# D. N. Shanbhag and C. R. Rao, eds., Handbookof Statistics, Vol.

19 ~'~
.g... ,,.2
© 2001 ElsevierScienceB.V. All rights reserved.

It6's Stochastic Calculus and Its Applications

Shinzo Watanabe

O. Introduction

It6's stochastic calculus is one of the most important methods in modern prob-
ability theory to analyze various probability models. In up-to-date applications,
for example, it provides us with a basic tool in the theory of mathematical finance
such as theory of derivative pricing.
A general framework of this calculus is usually given as a sample functions
analysis for a class of stochastic processes called semimartingales or generalized
Itd processes. A characteristic feature of a semimartingale is that it represents a
random motion in time perturbed by a noise; the noise is assumed to be a
martingale which represents a fluctuation around the main motion and the main
motion is assumed to be adapted and smooth in the sense that its sample function
is of bounded variation in time. Here, the martingale property and adaptedness are
referred to a given filtration on the probability space.
In this framework, we can develop a differential integral calculus for sample
functions. A basic notion here is stochastic integrals' and, by using this notion, a
fundamental formula in this calculus, now very well-known as Itd'sformula, can
be obtained. It is a formula for the change of variables or the chain-rule under the
differentiation for sample functions of semimartingales and, when applied suc-
cessively, leads to the Taylor expansion formula.
We can associate for semimartingales some of their characteristic quantities
such as quadratic covariational processes and compensating random measures for
jumps which may be considered as a natural extension of covariance parameters
of Gaussian components and L~vy measures, respectively, in the L~vy-Kchinchin
characteristic of infinitely divisible distributions or associated L6vy processes.
What is crucially important in this framework is the fact that fundamental noises
in probability models in continuous time such as Gaussian white noise (equiva-
lently Wiener process) or Poisson point process can be characterized in terms of
these characteristics of semimartingales. From this fact, we can extract funda-
mental noises in stochastic models; in other words, we can see how these models
are combined with noises. So, roughly, we could obtain stochastic equations
governing stochastic models. Typically, this is an It6's stochastic differential

873

874 S. Watanabe

equation for the Kolmogorov diffusion model. Using these stochastic equations,
we can construct and analyze the structure of stochastic models. Thus, besides
analytical methods based on differential equations. Fourier analysis and func-
tional and potential analytic methods like Hille-Yosida's theory of semigroups
and Fukushima's theory of Dirichlet forms, among others, stochastic calculus
also provides us with efficient and sometimes more direct probabilistic methods in
the study of probability models; such a probabilistic approach could in many
cases give a deeper understanding of results obtained by an analytical approach.

1. Semimartingales and stochastic integrals

1.1. General notions on stochastic processes
Let (~2,S , P ) be a probability space, i.e., a a-additive probability measure P
defined on a a-field @ of subsets in g2. We assume always that it is complete,
i.e., if A c B, B E Y and P(B) = 0, then A E S so that P(A) = 0. Let X =
{A g IP(A) = 0).
In this article, we consider random phenomena depending on the continuous
time; t E [ 0 , ~ ) . Of course, there are corresponding notions or results in the
discrete time case and they can be stated much simpler because there are much
less mathematical technicalities involved.
By afiltration, we mean an increasing family {St}tE[0,~) of sub a-fields of S :
StCS fortE[0,~) andStcSs if0<t<s .

A filtration is said to satisfy the usual conditions if
(i) Y C S 0 so that X c S t for every t c [0, ec).
(ii) t H S t is right-continuous in the sense that S t = ~s>tS~ for every t E [0, oc).
In the following, we assume that a filtration satisfies the usual conditions unless
otherwise stated.
By a random time, we mean a random variable T with values in [0, oc]. Given a
filtration {St}, a random time T is called an {St}-stopping time (or simply a
stopping time if the filtration is well understood), if
[T < t](:= {colT(co) _< t}) c S t for every t c [0, oo) .

Because of the right-continuity of {~-~t}, T is an St-stopping time if and only if
IT < t] E S t for every t E [0, oc). For an St-stopping time T, define a sub-a-field
S r of S by
Sr={AES[An[T_<t]ESt for a l l t ~ [ 0 , oc)} .
We introduce several notions concerning stochastic processes, i.e., a family
X = (X(t, co)) of random variables depending on the time t E [0, oo). We consider
a stochastic process X = (X(t, co)) taking values in a Polish space S; a Polish space
is a topological space with the topology given by a metric under which it is

Itd's stochastic calculus and its applications 875

separable and complete. Let 5 ~ be the a-field of Borel subsets of 5:, i.e., 5 ~ is the
smallest a-field on 5: containing all open subsets of S. X defines a m a p
x: [0, × (t, co) x(t, co) s .
X is called {~-dt}-adapted if for each t E [0, oc), the map f2 ~ co~-~X(t, co) E 5: is
o~t/SP-measurable. X is called {~t}-progressively measurable if, for every
t E [0, ec), the map X : [0, t] x f2 ~ (u, co) ~ X ( u , co) E S is N[0, t] ® ~ t - m e a s u r -
able. If X is {~t}-progressively measurable, then it is { ~ t } - a d a p t e d .
Two stochastic processes X and Y with the same state space 5: are considered as
the same and we write X = Y if
{col3t, x(t, co) ¢ y(t, co)} J< .

X is called right-continuous (left-continuous), or cfid (resp. cfig), if
\ {colt ~ X(t, co) is right continuous (resp. left-continuous)} ~ Y .
X is called right-continuous with left-hand limits, or cfidlfig, if
Q \ {co[t~--,X(t, co)is right continuous with left-hand limits} E Y .

X is called continuous if it is both right- and left-continuous. I f X is { f f t } - a d a p t e d
and cfid or {~-t}-adapted and cfig, then it is {fft}-progressively measurable. I f X
and Y with the same state space are cfid, or cfig, then X = Y if and only if, for
every t E [0, oo), {co[X(t, co) ¢ Y(t, co)} c Y .
Let ~ ((9) be the smallest a-field on [0, t ] x (2 with respect to which all {~-t}-
adapted, R-valued and cflg (resp. all {~-t}-adapted, R-valued and cfid) processes
X : [0, oc) × f2 --+ R are measurable. Then it holds that ~ c (9. This can be seen
from the fact that N coincides with the smallest a-field on [0, t] × ~2 with respect to
which all {~,~t}-adapted continuous processes are measurable.
is called the predictable a-field and (9 the optional a-field. 5: being a Polish
space, an 5:-valued stochastic process X is called {~t}-predictable ({~t}-optional)
if the map X : [0, oc) x f2 ~ (t, co) ~ X ( t , co) E S is N / ~ - m e a s u r a b l e (resp. (9/5 p-
measurable). Since ~ c (9, an {~-t}-predictable process is an { ~ t } - o p t i o n a l
process. An {~'t}-optional process is an {~-t}-progressibly measurable process.

1.2. Martingales and processes of bounded variation
Suppose that we are given a filtration {Yt}tc[0,o~) on a complete probability space
which satisfies the usual conditions. An R-valued stochastic process X =- (X(t, co))
is called an {~t}-martingale if it satisfies:
(i) it is adapted to {~-t}, i.e., X(t) is ~ t - m e a s u r a b l e for every t E [0, ec),
(ii) X(t) is integrable for every t c [0, ec), i.e., X ( t ) E La(f~,P) for every
t [o,
(iii) for every t > s > O,
E(X(t)h~-, ) = X(s) a.s.
i,e., E(X(t)IA) = E(X(s)I~) for all A E ~ s -

. cfidl~tg. ) I (2) /. A E A is called an {•t}-increasing process and V ¢ V an { ~ t }-process of bounded variation. Here. there is a cfidlfig {~t}-martingale X ~ such that X(t) = X'(t).A2 = (Az(t. ec)} . co) -A2(t. co) -. the following characterization of martingales in terms of stopping times is useful: A cfidlfig {~t}-adapted process X is an {~t}- martingale if and only if for every bounded {Yt}-stopping time T. and E(X(t) 2) < oc for every t E [0. co)} (5) and define V1.s. co)) defined by x (t. I f X = (X(t. (4) Denote by A pred and Apred their subclasses formed of all predictable elements. T is called bounded if T(co) < K a. co))l~A1 = (Al(t.. for every t E [0. Noting it. A(0..a. ec). < T~+I. we give the following definition: a cfidlfig {~t}-adapted process X = (X(t. Watanabe For a martingale X. co) -. a n d X r'. CO))[A E A and E(At) < oc for every t C [0. respectively. in (5). Set. co for some constant K > 0. co) is increasing for a. co))]M is an{~t}-martingale with M(0) = 0 a./Too Let A = {A = (A(t. co} (3) and A1 = {A = (A(t. a. A pred and Apred --1 .ioc of locally square-integrable martingales by M2. for any {~-t}-martingale X. co) = Al(t. limnTooTn = ec a.a. co)) E A such that V(t. we always assume that it is cfidlfig. co))lA is {~t)-adapted. and M r" E M2 for n = 1 2.. limT~ = oc a. V = {V = (V(t.s. Introduce the space M2 of square-integrable martingales by M2 = {M = (M(t. This fact is known as Doob's optional stopping theorem.0 and t~-+A(t. wPred' --lXtypred'similarly by replacing A with A1. further. then the stopped process X r = (Xr(t. co)) is an {Yt}-martingale and T is an {Yt}-stopping time.s. X(T) is integrable and E(X(T)) = E(X(O)).. Also. co)) e A.~oc = {M = (M(t.876 S. this is no loss of generality because. co))]3{Tn} : a sequence of {@t}-stopping times such that Tn _< T~+I. oc)} (1) and the space Ma.x(r(co) A t. co) is also an {~t}-martingale. is {~t}-martingale for each n. co)) is called an {~t}-local martingale if there exists a sequence { T.s.n}n=l Oo of {~t}-stopping times such that T. respectively.

1oclM is continuous} and V c . Itd's stochastic calculus and its applications 877 Let M~ = {M c M2[M is continuous}. . V) stands for the multivariate normal distribution with the mean vector m and the covariance matrix V.3. Stochastic integrals If V ~ V.. and we denote by lIVIl(t) its total variation on [0. j = 1 . J~t is the smallest a-field containing all P-null sets and with respect to which all X(s). Then X is a d-dimensional Wiener process. t for i .W i e n e r martingale if the filtration {Yt} is the natural filtration of X. An important consequence of the Doob-Meyer decomposition theorem for submartingales (cf. (resp. A pred1 ) and this is simply denoted by (M). M) E A pred (resp. i. one of M and N is continuous. are mea- surable. a. Dellacherie-Meyer.Md(t)). {o~t}-martingale). (M.MJ)(t) = (~i. as usual.X(O) is {~-t}-Wiener martingale.s. (t .. t]. defined by M(t) = X ( t ) . M i E M ° for i = 1 . . is independent of the a-field Ys. for M. Obviously. . N) is continuous if. 1.(M2). then it is easy to see that the process M = (M(t)).. t] ~ V(s) is of bounded variation. . For . This V is denoted by (M. Ldvy's martingale characterization theorem for Wiener process. 1980) is that. M(t) = ( M l ( t ) .1oo. Furthermore. then.X(s). Then IIVII E A. (6) A d-dimensional Wiener process (Brownian motion) X = (X(t)) is. i. continuous and {Wt}- adapted process (defined on a probability space with a filtration { ~ t } ) such that M = (M(t)) defined by M(t) = X ( t ) . d. d . t] H V(t) is of bounded variation for every t > 0. V ° c V pred and V c1 C vpred that M ° is exactly the class of all continuous {Yt}-local martingales M with M(0) = 0 and V ° is the class of all {~-t}-adapted continuous processes V such that V(0) = 0 and [0. for every s >_ 0. . s C [0. oo). . . there exists unique V E V pred. such that M(t)N(t) . This result is basically important in stochastic analysis: TI~EORE~ 1. is { J t } .V(t) is an {Wt}-local martingale (resp. Suppose that X = (X(t)) is an Rd-valued. vPred).X(s) for t > s > O. (M.s)I) as the law of X ( t ) . (Such a Wiener process is usually called {~-o~t}-Wiener process. It is called a d-dimensional {~t}-Wiener martingale if (Mi. N) and is called the quadratic co-variationalprocess of M and N. V c1 are -1 • Note also defined similarly. be a d-dimensional contin- uous {~-t}-local martingale with M(0) = 0.s.) 1.e. we have the fol- lowing result known as P.] I f X = (X(t)) is a d-dimensional Wiener process.e. (This filtration is always right-continuous. Wiener martingales and Wiener processes Let M = (M(t)) E (M°) d. 0 < s < t. . for each t E [0.4. M ° = {M E M2.) Conversely.j .X(O). t > s. . . at least. . N c M2. . a continuous Rd-valued process with stationary independent increments with N(O. the family X ( t ) . a. [N(m.

co) = J0' ~(u. co) . co))..1oc.N)(t)= f0'+ ~(u).1oc(M) = J ~ = (~(t. a.mc and 4)c L-q'2. for every L E M2. and. ~o))1~ is {~-t}-predictable and E '+~(s)2d(M)(s )l <ooforallt>0 } ... the following Schwarz-type inequality holds for every t E [0.N)H(u)<_ I/or+~(u)2d(M)(u)]I/2 × [Jot+~(u)2d(N)(u)l 1/2 (7) For a given M E ~/I2. co).d~. there exists a unique N C M2. ec) and n = 1.ioc such that. or simply by /0' e(...2. for every t E [0. (9) THEOREM 2.1oc.s.dM(. Watanabe {@t}-predictable processes ~ = ( q ) ( t . . let ( ~2. co)) and t P = ( T ( t . the following identity holds a. and call it the stochastic integral of (b(u) by M. E q~(s)2d(M)(s < oc (8) and ( =~2(m) = ~ ~ = (~(t.M)(u) (I0) The right-hand side of (10) is an co-wise Lebesgue-Stieltjes integral which is well- defined because of the inequality (7).s.1oc(M). co).d(L.) or / e.). co))l~b is {~t}-predictable and there exist a sequence {Tn} of {~t}-stopping times such that Tn -+ oc a. For given M E Mz.an(.878 S.. <L.: fo~+l~)(u)~(u)I "dlI(M. We denote this N by N(t.s.

E L-~2. dM = c~f q~.1oc./? C R. 6) If 45 is given in the form ~(t) ._<r]-dM(u) = M ( T A t)./4~k~ • dM . dM+ fl / Tt . t_> 0 .(p where T is {ft}-stopping time and ~o is a bounded fir-measurable real random variable.1oc(M) for every M C M2.1oc(M). we can conclude that. i. and • C 5¢2. t _> 0 ./ ~" dX)(') = f'+~(u)~(u) "dIM. 5) IfM.l [ T < t ] .dN.1oc. we have f0 t l[. for every {ft}-stopping time T..M ( t A r ) ) . The right-hand side is well-defined as a Lebesgue-Stieltjes integral because of the inequality (7).~oc(M) and .loc(M).1oc(M) and 7~ E 5~2.1oc(M) and / (o~b+ fl~P) .d(M)(u) .1oc and we have fo ~ ~(~) . then. then (f ~'dM.1oc(f~b. 7j E 5e2joc(M).dM+~/~.1oc(N). M C M2.1oc (M) and / ~ •d(/~b . then for every e.. (l[t_<r]~b(t)) ~ ~2. In particular.d(~M+~N)=~/~. kv E ~°2. t>0 . N E M2. then 4~ E 5°2. ~b +/~T = (~b(t) + / ~ ( t ) ) C S2.1oo. the stochastic integral by a continuous local martingale is again a continuous local martingale. dM .1oc(c~M+/~N) and f ~. I / q~. and ~bESC'2(M) nS~2(N). q~ C Y2. Combining this with 2.e.1oc(M). (M(t) ./~ER./0 . NEM2. 4) If M.1oc.dM)(t)= fot+~(u)2.N)(u). da¢(~) = ~o.~0t f TAt ~(u) l [ ~ r l ' d M ( u ) = ~(u). Itd's stochasticcalculusand its applications 879 The following are the fundamental properties of stochastic integrals: 1) If M E M c and • E Y2. 2) I f M E M2.d M ) = . then ~ 7 j E ~2. In particular.dM). dM E M c. 3) If ~.dM(u).. if • c Ya. then f~b. . then for every c~.

(M(Tk+lAt)-M(TkAt)) . p defines a counting measure Np(ds. are measurable. f ~b. a point process p on E is a (//z. Watanabe Furthermore. then ~b E ogaZ.e.s.N)(s). k = 0 . oo) ® ~ z by Np((O. for t > 0 and U c ~ e .N.P) and {fit} be as above.k=0 a. . Point processes and Poisson point processes Let (if. ] t>0 if • E ~2(M) and ~g E ~2(N).loc(M) for any M E M2.1oc and fo ~b(u). oo). ~ ( H s ) ) - .5. (12) A predictable process ~b of the form (11) is often called a bounded simple pre- dictable process. =E [/o q~(s)gJ(s). we mean a mapping p : I)p c (o. .880 S. ~_=) be a measurable space.t] x U) C N. Let (Y2. Then we have E I(/0 qS(s).W. d~) on (0.ioc(M). t> 0 . 7) For M E M2. By a point function on E.s<t Let Hz be the totality of point functions on E and ~(/Tz) be the smallest o--field o n / 7 ~ with respect to which the all the mappings Flz ~pHNp((O. . A point process is obtained by ran- domizing the notion of point functions. ~ok in (11) need not be bounded. k=0 t>_O . More generally.. t>0.1oc and ~b E oocza2.dM E M2 if and only if ~b E ~Cza2(M).t]x U ) = ~ 1u(p(s)). UE~z • sEDp.d(M. ~) ~ t ~ p(t) c s where the domain Dp o f p is a countable subset of (0. . ~ ) x E with the product a-field ~(0. and bounded Yvk-measurable real random variables %. Then the formula (12) holds for every simple predictable process ~.dM(u)=~-~Cpk. if ~0 is given in the form N • (t) = ~o0. i. l[t=0] + Z q)k • l[Tk<t<T~+~] (11) k-0 for a sequence fT~ 1N+I of {~t}-stopping times such that To = 0 and Tk < T~+I. 1. "t k.1 .dM(s =E ~b(s)2-d(M)(s . The assumption that (p and q~k are bounded is not needed when M E M C.

1oc for every n and B E 2 s • Np. with probability one. i. (ii) if U. oc) × 3. . for e v e r y s _ > 0 a n d B c 2 3 • The existence of the compensator is assured fairly generally: For example. Then t~--~Np([O. Itd's stochastic calculus and its applications 881 valued random variable. p is called a-finite if there exist U.t] × (Un 718)) -Np([O. Let p be an {Wt}-adapted. t] × B) = Np([O. as a function ([0. for E c 2([0. oc)) ® 2 z . for every t > 0 and U E 2 s . oc))® 2 z ) . 2 .oc. it is ~ ® 2 s - measurable.e. for some n and t > 0. the compensator always exists.s. oc) × S × f2 ~ (t. t] × (B riB')) × B) ×B. 2([0.. 3. B' C U. co). when exists. t] x B) . s . f o r s o m e n and it holds. t] × Un) < oo n a. t] × (U~ A B)) in (iii) above for a fixed B and n is guaranteed by the Doob-Meyer decomposition theorem. i. then Np([0.. 3) ~-~g(t.). t] × B'))--NA[0. n = 1 . ----~ and Np((O. for B. Note that the existence of Np([0. such that the following hold: (i) t~Np([O. /Np([0. 3. is uniquely determined from p by these properties and satisfies always 2Vp({s}xB)_< 1 a. 3. co) E R. . a-finite point process. (iii) t~--~ Np([O.t l x B ) cM2. t] × B). p is called {~t}-adapted if. c 2 e .e. oc) x e exists. . t]x U ~ ) < o c a . Np(E) is [0. co) ~-+g(t. t] x U) is ~t-mea- surable. such that Un C gn+l. E ~ N p ( E ) is a measure on ([0. for every t>0andn . eel-valued random variable and. if.t] × U) is {Yt}-predictable for every U E if.. for e v e r y t > 0 a n d n . are those subsets in the definition of a-finiteness of p. B' E 2 s such that B. Np((O. if S is a Polish space and 2 s is the Borel a-field. co) E R is called {~t}-predict- able. We say that p possesses the compensator Np if a nonnegative random measure Np(ds.Np([0. Suppose that p possesses the compensator Np and set /Vp([O. oo) × Q) × 3 E ((t. s<t A function IO.. Introduce the following classes of predictable functions: . p : (2 --+ H3 which is ~-/2(Hz)-measurable. d~) on [0. ifBc U. U U.Np([O.t](Un Me)) C M2. t] x B) .s. .

4.s. d~)] is an element in M2. it can not be defined an absolutely convergent integrals. d~) f o r f E F~ '1°c so that [t~ fo+ fzf(s. 4. d~) .~.co)lNp(ds.~.. co)]. co)If is {St}-predictable and E If(s. ~. co)Np(ds..d4) is well-defined as a Lebesgue-Stieltjes integral and coincides with the absolutely convergent sum E f(s. Np(ds. Note that integrals fo+ fzf(s.sEDp Next.p(s). Then we have E [f0t+ ~ If(s. co)Np(ds. co)Np(ds.co)]f is {fft}-predictable and E rf0t+j~sz If(s. 4.. ~. } . d~) < ec a. s<t. However. Define ft+ fzf(s.. ~. d~) < oc for all t > 0 {f(t.co) . the first integral can not be defined as a difference of the second and the third inte- grals. F1 C Fp. ~. 4. for all t > 0 Vlp= {f(t.} of {~t}-stopping times such that T. Watanabe f Fp = ~f(t.co)12.~.co)Np(ds. Details are given as follows: First we remark that.](t)' f(t. f o r f E Fp. and l[0. d4)l and hence. fo+ fzf(s.oo. co)]' Np(ds. We are now going to define the stochastic integral fo+ fsf(s.Np(ds.2. d~) = ft+ fzf(s. d~)l = E[f0t+ fz [f(s. co)Np(ds.d4) for f E Fp and fo+ fzf(s. co)If is {~t}-predictable and ]f(s. co)]. co) E I~2 for n = 1. ~.fot+ f=f(s. 4. co)If is {@t}-predictable and there exists a sequence {T. let f E Fp1.. d~) for f c F~ can be defined by co-wise Lebesgue-Stieltjes integrals.. 4.~.r. ~. co)Np(ds. co)Np(ds.~ip(ds. 4.s. ~ oc a. d~)] < oo for all t > 0} {f(t.882 S. 4.co)~p(ds.d4) -. in other words.

the caseNp(E) = ec a. 4.~([O.s t o p p i n g time T such that f(s.~oc having the following prop- erty: F o r every { ~ t } . co)Np(ds. d~)---+0 ] asn--+oc .s ~. 4.co)-f(s. then Np(E1).. This M is.s. (ii) f o r E C N([0.. co)q~(t)) E F 2'l°c.~. d~) ) . co)Np(ds. d~) and ~b = (~(t)) is {~-t}-predictable. d~)] EM2 and i fot+ fzf(s.~ is called a Poisson point process if the following are satisfied: (i) if E1.c. a point process p on . d~) . d~))t>_ 0"_ If M(t) -. Generally. the stochastic integral (f~t+fzf(..co)~p(ds.~. it holds that M T(t) = M(t A T) = f0'Zf(s.Np(En) are mutually independent. If f E Fpa n F 2..~.fo+ fzf(s.~.r] (s) E Fp2. it holds that The most important class of point processes is that of Poisson point processes..1oc(M) if and only if (f(t.co)12"Np(ds.co)Np(ds.. Under this condition. 4. then ~b E Y2. 4. Np(E) is Poisson distributed. then we can see that [t~-~ fot+ f f(s. . ~ d~) I f f E Fp2. fn(s. Itd's stochastic calculus and its applications 883 for f E Fp1. co)Np(ds.r] (s)Np(as. Finally. co) l[0. oc)) ® Nz. we can show that there exists a unique M = (M(t)) E ~/I2 having the property that E M(t). ~. d~)) : fo t+f f(s. by definition. d~) ---+0 asn--+c~ for any sequence fn E F 1 n F 2 such that E [J02 ]f~(s.>0 by this M.~. i f f ~ _p . we can show that there exists a unique M = (M(t)) E Mz.co) 2Np(ds.E. We define (So+Li(s.. co)l[0. being allowed as a Poisson r a n d o m variable with infinite expectation. oc))®Nz are disjoint..co)Np(ds.~.

. M = (M(t)) E Ma.2. Namely.P) and { ~ t } be as above. n = 1.1oc(M) and .. The class of semimartingales is important in the study of random phenomena in continuous time: Very roughly.884 S. • E ~2. t] x Un) < oc for every t > 0 and n.. . this property characterizes a Poisson process. then they are mutually independent if and only if their domains Dp. oc)) ® -~z) in the sense that there exist Un E Ne.. Just as the L~vy theorem in the case of the Wiener process. such that Un c U~+I. . V(t) is the noiseless motion (mean motion) which is. N([0. ec) x S. Semimartingales Let (~2. A a-finite {~-t}-Poisson point process p possesses the compensator Np which coincides with the deterministic measure Vp. An {~t}-Poisson point process p is a-finite if and only if Vp defined by vp(E) = E[Np(E)] is a a-finite measure on ([0. which is obvious because Np is a counting measure of a point process. 1988): THEOk~M 3.6.loc and V = (V(t)) E V. ec) × ~. U~ U~ = ~ and vp([0. . a. 1. If an {~-t}-adapted a-finite point process p possesses the compen- sator which is a deterministic measure on ([0. given an infinite and a-finite deter- ministic measure v on ([0. I f X = (X(t)) is an {~t}-semimartingale given in the form of (14). Ikeda-Watanabe.t] x B). Watanabe An {~t}-adapted Poisson point process is called an {Yt}-Poisson point process if. a. if p l . for every s > 0. ~([0. is inde- pendent of the a-field ~ . (13) This corresponds to the fact that Np({s} × 3) _< 1.. disturbed by a noise and the fluctuation from the mean motion caused by the noise is given by M(t).t >_s.s. we have the following fundamental fact (cf. N([0. Vp satisfies always Vp({S} x S) = 0 . the family Np((S. then we define ~b = (4~(t)) E •(X) if and only if • is {~t}-predictable.~. oo)) ® ~ ) having the property (13). are a family of { ~ t } - Poisson point processes. there exists an {~t}-Poisson point process (on a suitable probability space with a filtration) having v as its compensator. t h e n p is an {~t}-Poisson point process. are mutually disjoint. oc)) ® ~ s ) . {@~}-adapted and cfidlfig process X = (X(t)) is called an {Yt}-semimartingale if it is represented in the form X(t) = X(O) + M(t) + V(t) (14) where X(0) is ~0-measurable. furthermore.s. An R-valued. A family of {Y/}-Poisson point processes are always independent of any family of {~-t}-Wiener processes and.. It is sometimes convenient to define the stochastic integral by a semimartingale.B E ~ .p. however. Conversely. ec) × ~.

. We call V the drift part of the continuous semimartingale X and denote it by Vx. however. The decomposition x(t) = x(o) + Mx(t) + vx(t) (16) is called the canonical decomposition or semimartingale decomposition of the continuous semimartingale X. Thus. Consider a particular case in which Mx and Vx are given in the form . an {Yt}-semimartingale defined by = ~b(s)dM(s) 4. In (15). V(0) = 0. f(s. Conversely.) . We introduce a seemingly restricted class of semimartingales. X is continuous.co) = ~-111~_1_<1](~) . Let X = (X(t)) be an R-valued. in particular.co) = ~. by definition. in general.0. Cf. Although the expression of X in the form (14) may not be unique. f E Fp and g E F2'1°c such that f . M is uniquely determined from X: We call it the continuous martingale part of X and denote it by Mx. the definition is irrelevant of a particular expression and the stochastic integral is uniquely defined from ~b and X. It is not difficult to see that X given in the form (15) is an {ft}-semimartingale. (ii) M C M C so. M(t) 4. ~. Jacod-Shiryaev. ~b(s)dV(s) . d~) + f'+ g(s. (iv) p is an {ft}-adapted. oc)lX(t ) C X ( t . V(t) 4. 1987 for details. in particular. The stochastic integral fo + Cb(s)dX(s) of ¢ E S ( X ) by X is. then the de- composition X(t) = X(O) 4. any {ft}-semimartingale X can be represented in the form for a suitably chosen { f t } . p is naturally defined by the discontinuities of X as 3 = R \ { 0 } . M(0) = 0.a d a p t e d point process p: Indeed. 1[[~1>1](~).) } . If. a-finite point process on some state space (3. p(t) = X(t) .~. co)Np(ds. M(t) 4.Io where the second integral in the right-hand side is the co-wise Lebesgue-Stieltjes integral. equivalent to the class of all {Yt}-semimartingales. as we shall see. in particular.X ( t . for every t > 0. D p = {tE (O.~. 9 . (15) where (i) X(0) is an fr0-measurable real random variable. (iii) V E V C so. t E Dp and f(t. {Yt}-adapted and c/Ldlfig process given in the form X(t) = X(O) 4. V(t) is unique. this class is. it is no loss of generality to introduce this class of R-valued processes as semimartingales.s. #. g(t. Ne) possessing the compensator Np. Itd's stochastic calculus and its applications 885 J'0+ I~(s)ldll vii(s ) < oe a.

.Xd) be a real-valued cg2-function on R e. xd(t)). f0 I~(s)l 2ds < oc for every t > 0. 4. i.e. . Y0-measurable real r a n d o m variables.s.. and 7~ is an {Yt}-predictable process such that J0 I~(s)[ as < oc for every t >_ 0. . i = 1 . X ( t ) = (Xl(t). .. t. 2. by xi(t) = xi(o) -[. . a.. the following are given: (i) xi(o). co)) E Fp. Denote also f = ( f l . (iii) V i E V c.. co)Np(ds.. d . where B is a one-dimensional {@t}-Wiener martingale. co)] < M for all i. a-finite point process p on some state space (Z. 4. . d~) + gi( s.. f d ) and g = (gl.1.. . co)" gi(t. . (9)) E F 2'l°c such that fi(t. so that X is given in the form X(t) = X(O) + f0 t ~b(s)dB(s) + T(s)ds .. . . . . Such a process X is called an Itd process. 4. there exists a positive constant M such that Igi(t. 4.. Itd's formula Let (Q. a.s... (iv) an { ~ t } .0. d . co) . i = 1. . d. co. we as- sume that gi(t. semimartingales are a general- ization of classical It6 processes and.-~z) possessing the compensator Np a n d f i = (fi(t. on this space. gi = (gi(t.. . furthermore. ~ . 4. P ) and {fit} be as above. Stochastic calculus for semimartingales 2. Thus. Let F(x) = F ( x l . . . . i..a d a p t e d . (ii) M i c M c. . i = 1 .886 S. . they are sometimes called gen- eralized It6 processes. . ~. . i 1 .e. co)Np(ds.Xd(t))) is also an {~t}-semimartingale and the following holds: .. Suppose.. Vx(t)= f0t ~U(s)ds .. d.gd). co) are bounded. 4. d~) (17) for i = 1 ... • E ~°2. 4. Define a d-dimensional {Yt}-semimartingale X = (X(t)). therefore. Then F(X) = (F(X(t)) = F ( X l(t).ioc(B). . Watanabe Mx(t)= f0 eb(s)dB(s). 4. d. An It6's formula is stated as follows: THEOREM 4. . ..Mi(t) + vi(t) + fi(s. .

d4) + 7o7 { e(X(s-) + g(s. i=1 Here. Itd's stochastic calculus and its applications 887 d t F(X(t)). X(t)= (Xl(t)... 4.F(X(s-))}Np(ds.F(X(s-))}Np(ds.F(X(O)) = E /ot( i=1 aiF)(X(s))dMi(s) + /ot( i=1 5iF)(X(s))dVi(s) l d ~ot + 2i.E gi(t' ~' ")" (aif)(X(S--)) (ds. i= 1. ")) . ")) .xd(t)) is a continuous d-dimensional semimartingale given by xi(t) = xi(O) + Mi(t) + vi(t).~j ~i. then F(X(t)) . ")) ... 4. = (a?Y) (X(s -)) d (Mi (s)' Mqs)) (s) + [ t + [ {F(X(s-) + f(s. In other words. the martingale part MFoX and the drift part VFoX of the contin- uous semimartingale F o X = (F(X(t)) in its canonical decomposition are given by d t MFoX(t) = E fO (5iF) (X(s))dM i(s) i=1 and d t aox(t) = ~ f (aiF)(X(~)ldV'(s) i=1 + 2 ~.= (~j~iF)(X(s))d(Mi(s)'MJ(s))(s) .d .F(X(O))= ~ ~o (SiF)(X(s-))dMi(s) d t + E f (aiF)(X(s-))dVi(s) i=1 + 2 ~..g(X(s-)) -.. If. d4) . 4.10 dE + {F(X(s-) + g(s.~1.~j l fot (ajaiF)(X(s))dIM'(s)'MJ(s))(s) " . in particular.. d4) . ~iF = ~F/Oxi..

respectively. To be precise. X i E S.dX)=d(f@-dMx)+d(. Y. dX i + ~ Z(ajaiF)(X) . that of Stratonovich differentials. dZ E dS. . as follows: Let X ( t ) = ( X l ( t ) . d .2.dX=d(/q~.s.s.f@. Denote by dM and dV the subclasses of dS formed of all stochastic differentials of elements in M c and V C. (20) i=1 i. Then F ( X ) = (F(X(t)) E S and a 1 a dF(X) = Z ( a i F ) ( X ) . Let S be the totality of continuous {~t}-semimartingales X = (X(t)) with the canonical decomposition x ( t ) = x ( o ) + Mx(t) + vx(t) . Itd's formula in stochastic differentials and the Stratonovich stochastic differentials Let (~2.888 S. t >_ 0.d Y E dV and d X . Z E S. and define d X . d Y E dS and cq/~ E R. dZ = 0 for every dX. Let dS be the space of all stochastic dif- ferentials dX for X E S. Watanabe 2. My). . Y .j=l We are going to introduce an important operation on the space OS.dY. Let B be the totality of R-valued {Jt}-predictable processes such that SUpsci0. so that dS = dM ® dV (a direct sum). . . .dY . d X j) . Noting S c B.dVx) • @ • dX is uniquely determined from @ c B and dX c dS.dY + 2 dX.Y(0). B C 5~2. define ~dX +/?dY E dS by d(0d2 +/~Y). Then.1oc(M) for every M E M C. Note that @. dY E dS by d{Mx. i = 1 . dX. X . For dX. P ) and {Yt} be as above.t] I@(s)[ < oc. Y E S. in this context. so that dS is a commutative algebra over R under these operations.X(O) = Y(t) . and F be a cg2-function: R d ~ R. dY. Note that d X . dX(t) m a y be considered as the equivalence class containing X E S under the equivalence relation ~ defined by. X ~ Y . (dX i. Ito's formula can be stated. for all t > 0. a. These stochastic differentials obey the following rule: for X. Y c S by XodY=X. . d Y = 0 if one of dX and dY is in d r . if and only if X ( t ) . (18) We write formally X(t) -X(s) = dX(u) (19) and call dX (denoted also by dX(t) or dXt) the stochastic differential o f X E S. In particular. a. . define X o d Y E dS for X. Define @ • dX E dS for ~ c B and dX E ¢1S by @. N o w (19) may be considered as the definition of the integral in the right-hand side for dX E dS. . X a ( t ) ) . .dX E dM if dX E dM. (21) X o dY is uniquely determined from X and dY and is called the Stratonovich stochastic differential or a stochastic differential o f the Stratonovich type.

V c. . (24) A one-dimensional {~t}-conformal martingale (local conformal martingale) is simply called an {~t}-conformal martingale (resp. n. (22) i=1 This chain rule for stochastic differentials takes the same form as in the ordinary differential calculus. .d X / 3 . n (25) . Itd's stochastic calculus and its applications 889 X o (dY + dZ) = X o d Y + X o d Z . Then F(X) = (Y(X(t)).. (23) (23) implies. dX[ = dYt~. X ~ E S. (SiF)(X) = ((SiF)(X)(t)) C S and d de(X) = Z ( ~ i [ / ' ) ( X ) o dX i . coordinate-free) notions probabilistically./3 = 1 ... Xo(YodZ)=(XY)o(dZ) . This is the reason why the use of Stratonovich stochastic differentials is quite convenient in transferring notions used in ordinary calculus into stochastic calculus and in defining intrinsic (i. d Y = fo X (s). S and the corresponding spaces of stochastic differentials in an obvious way and denote them by the same notations..~t}-conformal martingale (local conformal martingale) if. . Zn(t)) be a Cn-valued.d. dZ) = (iVo dY). P) and {~t} be as above.d Y = ( f0 X . 2. ~.dYt~ = 0.. . Then (23) is equivalent to dZ/. d Y f . dZ). dXt~ . ~ = 1. i = 1. . local martingales) satisfying the following conditions: dX?. for every ~ = 1 .n . n .e.. . . dYt/3. Stochastic calculus for complex martingales and conformal martingales Let (~2. in particular.Y . n .. X o (dY. a. . . It6's formula (20) can be rewritten as follows: Let X(t) = (Xl(t). Using this operation.dZt~ = 0. that dX[_ff. and F be a @-func- tion: R a -+ R. .. We say that Z is an n-dimensional {~. Let Z = (Z(t)). . The process f x o d~Y = ( fo X o dY = f~ X(s) o dY(s))t>o is called the stochas- tic integral of X by Y in the sense of Stratonovich or of the Stratonovich type whereas the process f X. Y~(t) and Y~(t) are {~t}-martingales (resp. . ( X + Y) o d Z = X o d Z + Y o d Z . dZ = X . d Y t ~.../3= 1 ... d Y(s))t>0 that in the sense of Itd or of the Itd type. . Write z (t) = x (t) + = 1..... We complexify the spaces M c.. continuous and {@t}-adapted process.3.. .. Z(t) = (Z 1(t). local conformal martingale).Xd(t)).. (dY..

B 2~(t)) is a 2n-dimensional {~t}-Wiener process. local martingale) for every e and satisfies (25).. given in the form of stochastic differentials as df(((t)) = Z~=1 ~x~ a f (((t)). B 2(t)... . .(dYt~. x~. ../~dt.. dZ[.~t}-conformal martingale (local conformal martingale) if and only if Z ~ is {~t}-martingale (resp.B2a-l(t) -}. e. dZ~. dX~ ÷ (((t)).890 S. ' e~-2 ~ v/-L7 Then It6's formula for an 2n-dimensional continuous semimartingale = (xl(t)..d ~ ~ 1 d a2f ak + 2~x~-7(((t)). we have the fol- lowing characterization theorem for an n-dimensional {~-t}-complex Brownian motion: THEOREM 5.. ..Yn) be a complex-valued cg2-function on R 2n.. . By setting z~ = x~ + v/-ZTy~.xn(0.. Watanabe so that Z(t) = (Z l(t).d2~=28~.. n . By the L~vy characterization theorem of Section 1.n where B(t) = (B 1(t).. A typical example of n-dimensional {gt}-conformal martingale is the n-dimensional { ~-t}-complex Brownian motion Z = (Z( t) ) which is defined by Za(t) ~. . . 0~= 1.. . .. . .. (dX?.. rl(t). Introduce the differential operators as usual: &~-2 ~x~ . .. ~ = 1.n. it can be regarded as a (g2-function f ( z l . Let f ( x l ..~-gB2C~(t). f l = l .dYf) can be rewritten in the complex form as follows: Setting Z(t) = (Z 1(t). B 2~ ~(t)... A C~-valued. Zn(t)) where Z"(t) = X ~ + x/TTf~(t).~t}-adapted process Z = (Z(t)) is an n-dimensional {~t}-complex Brownian motion if and only if dZ[EdM.. continuous {~.dZ~=0.. ...yl. Zn(t)) is an n-dimensional {~. dYf) + ~(~(t)) ...v / T ] .. .&) on C "..3. . . ..

. Define a new filtration {Yt} by ~. i. respectively. Then. dZ t ~ az~ (28) F r o m this. di~t~) ) . (27) c(. . NI c. df(Z(t) ) = + ( S f (Z(t)). we can conclude that f(Z(t)) is a local conformal martingale.s. ~¢c. Let A E A c.fl=l P Hence. (dZ t • dZt~) ... .a d a p t e d continuous process such that A(0) . for each fixed u _> 0. Itd's stochastic calculus and its applications 891 df(Z(t)) = Z ~77z~(Z(t)).s.. 8f/~2~ = 0. Z n (t)) is an n-dimensional {o~t}-local conformal martingale. .~t}-stopping time.4. dZ~) + ~ ~2f (~(t)) • (dZ~. Assume further that t ~ A(t) is strictly increasing and limtTooA(t) = oo. then ¢ = (~(t)) defined by ~(t) = f(Z(t A r)) is an m-dimensional {fft}-local conformal martingale provided that Z = (Z(t)) is an n-dimensional {Yt}-local conformal martingale and T is an {Yt}-stopping time such that Z(t A T) E D for all t > 0. by S.p~_l(~Z--~( eV + 2~z-~ (Z(t)).e. dZt + ~ (Z(t)).0 and t ~ A(t) is increasing.e.~t = ~A. The spaces S. a. A~-1 is an {~. A = (A(t)) is an { ~ t } . V c with respect to this filtration are denoted.s. (26) If Z(t) = (Z 1( t ) .. then df(Z(t)) = + ~f (Z(t)). a.d Z f ) + ~c~. dZ~ + ~ (Z(t))" d Z t ) ~ \Sz~ + (Z(t)).. then by (25). M o r e generally. Let u ~ A~-1 := min{tlA(t ) > u} be the in- verse function of t ~ A(t). i f f is holomorphic i.. d27 cz= ] 52f Z (t))" ( d Z / .. i f D is a domain in C ~ and f : D --+ C m is holomorphic. t >>_O. ( d Z / . M c. . a. Time change It is important to notice and apply in m a n y problems the fact that the notion of semimartingales is invariant under a class o f time changes. 2.

1oc(MA) and we have If. . which.. be given and satisfy the following condition. Ikeda-Watanabe. . Essentially by Doob's optional sampling theorem. then there exists a one dimensional Wiener process B = (B(t)) with B(0) = X(0) such that x(t) =B((M)(t)). N C M C.. N A} = ( ( M . N } ) A for every M . with B(0) = X(0) = (X 1(0). Hence ~t is an {~t}-Wiener process by L6vy's characterization theorem.j= l. Knight: THEOREM 7.892 S.. is in M c. t >_ O. L e t X i = (Xi(t)) C S. and a bijection between V C and 9c. i. In particular. we have that the mapping X ~ X A defines a bijection between the spaces S and S. . An invariance of the stochastic integrals under the time change can stated as follows: If ~ E 5¢2. . . in particular. we have MxA = ( M x ) A and VxA = (Vx) A for any semimartingale X ~ S . M J ) ( t ) = O. In this way.1oc(M) then Vt E ~2. We call X A the time change of X determined by A. Watanabe For an {Yt}-progressively measurable (-predictable. Then we have := M (M) = M((M}t 1) E 1VIc and (M)(t) = { M } ( ( M } t 1) = t .-optional). B(t) = (B l ( t ) .s. . Such a representation of a continuous martingale by a Wiener process is valid in a more general situation.Xd(0)) such that . Indeed. it holds that { M A .d. . define a new process X A = (XA(t)) by X A ( t ) = X ( A [ 1 ) . 1988): THEOREM 6. M(t) = B((M)(t)) .. Furthermore. i = 1 . defines a bijection between M c and lVl~. X A = (xA(t)) is {~t}-progressively measurable (resp. Then there exists a d-dimensional Wiener process B = (B(t)). Namely. d . defined by M ( t ) = X(t)-X(O). -optional) process X = (X(t)). If X = (X(t)) is such that M = (M(t)). a. t_> 0 . . we have the following important result due to F. Bd(t)). . . restricted. M i ( t ) := x i ( t ) . t ~ (M)(t) is strictly increasing and limtTo~(M)(t) = e~.-predictable. . This representation theorem for continuous local martingales can be further ex- tended to the multidimensional case. . then we can take A := {M} to make a time change. we have the following fact (cf.. M E M c. Then. we have the following representation of M by means of an {Wt}-Wiener process B := ~r.x i ( o ) E M c and ( M i .

dX..= f0' d~. The exponentials and iterated integrals of semimartingales Given X -. Also.(X(t)) E S and an ~ 0 . We state a result in the case of the complex dimension 1 only. . It6"s stochastic calculus and its applications 893 x i ( t ) =Bi((Mi)(t)). for example. i = 1. (/0' = dX~-dX~.. equivalently.. B. dX.d Y = 0 . Davis applied it to prove Picard's theorem (Davis.. (29) This result can be localized for a holomorphic function f in a domain D c C as f ( z ( t A r)) = ~ (4s))ds (30) for a stopping time T such that z(t A T) ~ D.. where we set (z)(t)=2 dZ. 2.5. equivalently. such that z(t) = z((Z)(t))..m e a s u r a b l e real random variable t/.dY and d X . dYEdM. a planar Brownian motion (x(t).dX=dY. then f(z(t)) is a local conformal martingale. Next we consider the time change for complex martingales. Then ZA(t)= (ZI(A~-I). t _> 0 . t >_ O. though. we see (f(z(t))} = fo ]~f/Sz]Z(z(s)) ds" Hence we can find another com- plex Brownian motion ((t) such that f(z(t)) = ( (z(s))ds .Zn(A2I)) is an n-dimensional {~t}-local conformal martingale. . It is easy to see that the class of conformal martingales are invariant under the time change: THEOREM 8. THEOREM 9.d~ ) . By It6's formula. there exists a unique Y = (Y(t)) E S which satisfies . i.d2. Let Z = (Z(t) = X(t) + ~ L 1 Y ( t ) ) be a C-valued continuous { ~ t } - local conformal martingale. . we note that if z(t) is a complex Brownian motion and f : C ~ C is holomorphic.d . t > O.Zn(t)) is an n-dimensional {~t}-local con- formal martingale. . I f Z ( t ) = ( z l ( t ) .. The representation formula (29) or (30) is useful in the probabilistic approach to problems in complex analysis. . As a typical application. dZ E dM and d Z . 1975). t> 0 . there are similar representation theorems for conformal martingales by complex Brownian motions.y(t))..e. we can extend the Knight theorem in the context of multi- dimensional conformal martingales. Then there exists a complex Brownian motion z(t) = x(t) + ~ f y ( t ) . dZ = 0..

is satisfied. [ { 1 }] E exp M(t)-~IM)(t) =1 for allt_>0 if the following condition. It is a true martingale. equivalently.. in particular.(O = jo x. n = 1. This fact can be shown by an easy application of ItS's formula. in particular... If.(M)(t)/2} satisfies d X ( t ) = X ( t ) . } .X ( O ) ) _ 1 f t ( d X . t for all t 2 0 a. by X 1 (t) ~. X.dX(t). known as Novikov's condition. x2(t) = jo Xl(~)dX(s). define X~ E S..X ( O ) . If dX ¢ dM.x ( 0 ) } . Y(0) = t/ (31) and this Y = (Y(t)) is given explicitly by Y(t) = r/. Given a continuous semimartingale X E S. for some constant C > 0. dM(t) ¢ dM. l(~)dX(s)...x... (31) is given in the Stratonovich form as dY(t) = Y(t) odX(t). Thus exp{M(t) .exp (Mx(t) + Vx(t)) .... (35) Hence if.(M}(t)/2} is a true martingale. r(0) = ~ . on the other hand.X ( t ) .1E because X(t):--exp{M(t). then Xn ~ M c for every n. Watanabe dY(t) = Y(t). (34) I f M = (M(t)) E M e. exp{X(t) .. then exp{M(t) .(M)(t)/2} is a positive local martingale and hence satisfies E [exp { M(t)-~IM)(t) 1 }1 _<1 for allt_>0 . E[exp{lIM}(t)}J <oc forallt>_0. (33) then the unique solution is given simply by Y(t) = ~. .894 S. we have { exp M(t) -~(M)(t) .2. (M)(t) <_ C. e x p ( (X(t). d X ) ( s ) } = q.5 {Mx)(t) (32) where X(t) = X(O) + Mx (t) + Vx (t) is the canonical decomposition ofX.s.(t) is called the n-fold iterated integral of X. the Eq.

Change of drift ( M a r u y a m ~ G i r s a n o v transformation) Let (f~. (36) These formulas are obvious. Z . n=0. DM(t) is a positive local martingale and we assume that it is a true martingale. t _> 0. x I = x 3 . H.x. n = l .x]=(-t) nexp ~ ~5. . t>_0. at least formally.t.(t)=~Hn[(Mx)(t).~ ( M x ) ( t ) l e~ ~n . Let M E M c and set 1 DM(t) = exp i. For this.X ( 0 ) ) . t>0. H2 [t. -X(0)].= Vt>0 ~ t . x(0)] n=0 co = Z nxo(t) n--O This relation is a consequence of a formula for Hermite polynomials: and the fact we saw above that Y~o(t)is the unique solution of the equation dYA(t) = )~Y.Y. I t d ' s s t o c h a s t i c calculus a n d its applications 895 Let Hn[t.P) and { Y t ) be as above.. [-I3 [t. which we can assume without loss of generality) such that/5(A) = E[DM(t-) • 1A] for all A E ~-t.. @) (when (O. ~ ) is a nice measurable space and ~..exp ~ . . .. X ( t ) . from the relation j~2 Y). Then there exists a unique probability measure/5 on (t2. x] = x 2 .~(t) ..(t) := exp [ 2 ( X ( t ) .6. . . as we saw above. Then we have the following explicit formulas for iterated integrals: X. dX(t).M(t ) . x] = 1. . Y. Let X ( t ) = X(O) + m x ( t ) + Vx(t) be the canonical decomposition of X. x] = x.X(t). xER. [(Mx)(t).~ (M)(t) } (37) Then. So we have E[DM(t)] = 1 for all t _> 0.z(O) = 1 . . be the Hermite polynomials so that Ho It. 2.3xt.1.... it is sufficient to assume the Novikov condition (35) as we saw above. H1 [t.

Conversely. we started with a given density DM and then constructed a probability/3 which is equivalent to P in the sense that P a n d / 3 are mutually absolutely continuous if they are restricted to Y t for every t > 0. it holds that (~lx. Y.. E M2 such that (Mi. we can show the following: THEOREM 11.4x(t) + . Y . Y E S .. X. P) formed of all square-integrable Vt>0 ~t-measurable real random variables is separable.. X E S. 2.M)(t) and x(t) = vx(t) + (Mx. that is. it is an important and interesting problem to study the structure of these spaces of martingales. Indeed. i. with the ca- nonical decomposition X(t) = X(O) + Mx(t) + Vx(t) . Assume that M2. it is essential to know the space of martingales M2. (40) Furthermore.1oc or Me.~t}. (M1} >> (m2) >> "'" and every M E M2 can be represented as a sum of stochastic integrals for some N-predictable processes q~i E ~2(Mi): . Then. 1974): THEOREM 12. We assume that the filtration is separable in the sense that the Hilbert space L2 (Q. Here is an important general result due to M. Varaiya (Davis-Varaiya. In the above. if P is a probability on (O. (41) This result is known as Girsanov's theorem.M)(t) .e.(Mx. The transformation of the proba- bility measures given above is called a transformation of drift or a Maruyama- Girsanov transformation since it produces a change of drift part in the semimar- tingale decomposition as given by (40). is given by DM(t) in (37) for every t _> 0. Y ) which is equivalent to P in the above sense. Davis and P. (39) with f/ix(t) = Mx(t) . (38) On the probability space (g2.. every {~.896 s. P) and { ~ t } be as above.H. Filtrations and martingales Let (O.1oc = M c. x ( t ) . X is still a continuous {Yt}-semimartingale but its canonical decomposition is given by x ( t ) = x ( o ) + . Vt>0 Yt.7. Let X be a continuous semimartingale. In order to know the filtration {~. There exist M1.My).mj) = 0 ifiCj.A4y) = (Mx. Watanabe THEOREM 10. restricted to @t.~t}-martingale is a continuous martingale.M2./3) with the same filtration {@t}. then there exists a unique M E M C such that the density d['/dP.

we can see that every (not necessarily square-integrable) martingale M (M(t)) with respect to the filtration { ~ x } such that M ( 0 ) = 0 is in MC({~x}) and hence has the representation (43). COROLLARY 1. M2({~-x}) = M~({~.d . f~l~i(s)12ds < oc for all t_> 0. N2. Then. respectively. the number of such M1. (1) The Brownian filtration Let X(t) = ( x l ( t ) .. (M25 ~ (N25. d. P) and let { ~ x } be the natural filtration of X. holding almost all co. The spaces M2.. Set Bi(t) = xi(t) .. • • is an invariant of the filtration {~t} which we call the multiplicity of {Jr}. i = 1 . every martingale with respect to the natural filtration {Y~} of X can be represented as a sum of stochastic integrals by the basic martingales {B i} of (42). there exists an {~tX}-predictable process ~i with E[fol~i(s)12ds] < oo for all t > 0 (resp.Xd(t)) be a d-dimensional Wiener process defined on a complete probability space (f2.1oc and M2 of Section 1.).. • is another such sequence. . i= 1. s <_ t are measurable. of the Stieltjes measures associated with increasing pro- cesses.. J~tx for t _> 0 is the smallest a-field on ~2 containing all P-null sets and with respect to which all X(s). >> and ~ denote the co-wise absolutely continuity and the equivalence.2 with respect to the filtration ~-~ are denoted by M2. Dellacherie. This is because M can be approximated. .. M2. respectively. compact uniformly in t in probability. .. Here. ..1oc and M2. a. by bounded martingales . such that t M ( t) q~i(s)dB i (S) . (43) That is.s.1oc({Jtx}) and Mz({~tx}). We give two important cases in which we can completely describe the structure of the spaces M2. THEOREM 13.1oc({~x})). If N1. 1974) Let M E M2({~-x}) (M2. 1967.xi(o). From this. .. • In particular. . (42) so that B i (Bi(t)) E Mz({~-x}). (Kunita-Watanabe. This filtration is always right-continuous so that it satisfies the usual conditions. Itd's stochastic calculus and its applications 897 M= fe dMi. then (M1) ~ (N1)..~x}) and M2. .1oc({~x}) MC({~tx}) . . ~ .

for each t _> 0. (46) Here. Ikeda-Watanabe. 2.exp(aW(t)+ [#-a---~]t) . Applications to mathematical finance Consider a simple financial market in which two kinds of assets. Nz) and.E ( F I ~ -x) is square- integrable. ~. B(t) and S(t) are uniquely determined by the following equations on stochastic differentials: dB(t) = rB(t)dt..s.loc({~P})) can be represented in the form M(t) = ['+ [ •/ 0 . . COROLLARY 2. there exists {ytX}-predictable q~i with fN i~i(s)12ds < oc. by B(t) and S(t).1oc ({ ~--p t})- 2. We consider a model introduced by F. Fp. (44) S=I 0 E[J N I~i(s)12ds] < oc for a l l / = 1 . Watanabe which are necessarily continuous and hence M is continuous. 1973). . the stock volatility and the stock drift. Then note that any continuous (local) martingale is always locally square-integrable. P) with a filtration {Yt}t>_0 satisfying the usual condi- tions and denote the price per unit of the cash bond and the stock. As a mathematical model. at time t. In the following. (2) The Poissonian filtration Let p be a a-finite Poisson point process on a complete probability space (Q. d . a riskless cash bond and a risky stock. B(0) = 1 (47) dS(t) = ~S(t)dW(t) ÷ #S(t)dt. we only consider the time t in the finite interval E0. (45) for s o m e f E F p (2{ ~p. s] x U). a. . . .~) with values in (E. we consider a probability space (f2. Y . . S(O) = So • (48) . are traded. 1974. ~ P be the a-field on ~ generated by P-null sets and random variables Np((O. a > 0 and # c R are constants called. So is a positive constant. and r _> 0.. Then. Black and M. such that F = E(FI@ x) + ~i(s)dBS(s) . T] where T is a positive constant called the maturity. s < t and U E -~z. W(t) is a one-dimensional {J~}-Wiener process with W(0) = 0. respectively. now well-known as Black-Scholes model: B(t) and S(t) are given by B(t)=exp(rt). .(resp. riskless interest rate.]~ f(. Let N > 0 and F be an ~-X-measurable and integrable real ran- dom variable. (Dellacherie.898 S. . respectively. THEOREM 14. d if and only if F . (B(t)) and (S(t)) are {o~t)-adapted stochastic pro- cesses. Scholes (Black-Scholes.}). 1989) Every M E M2({~P}) (Mz.8. S(t)=So. i = 1 .

6.s. since d X ( t ) . F o r example. t E [0. a .. This contract is called an European call option. Y r ) such that it is equivalent to P and S(t) = e ~tS(t) is {~t}-martingale under P*.K)+ = (S(T) . . ~b(t) and 0(t) denote the a m o u n t (i.d X ( t ) = o-2dt. respectively_It is easy to see by It6's formula that n = (~b. (iii) V~(T) = X. K is called the strike price or the exercise price. 0) replicates X or rc is a replicating strategy for X if it satisfies the following: (i) ~ is self-financing. 0) is called self-financing if it satisfies V~ c S and dV~(t) = d?(t)dS(t) + O(s)dB(t) . Itd's stochastic calculus and its applications 899 Indeed. we mean a pair ~z = (~b. By Theorems 10 and 11 of Section 2. we assume always that the filtration { ~ t } is the natural filtration of W = (W(t)). The payoff of this contract is obviously (S(T) . a. 0) is self-financing if and only if V~ c S and dV~(t) = ~b(t)dS(t) . at maturity T.¢) and ~ ' = (~b'. we consider it as a payoff or a claim which we can receive at time T of maturity. If a replicating strategy for X exists. 0) of {~-t}-predictable processes q~ = (~b(t)) and ~.(~b. consider a contract that. it is obvious for B(t). s . The value V(t) = V~(t) of the portfolio ~ -.K) V 0. T].. 0) at time t is given.s. In the Black-Scholes model. therefore.s. we can see that there exists a unique probability measure P* on ( ~ ..5 with X(t) = a W ( t ) + # t and. we say that the payoff X is replicable. (48) is the case of Eq. They may take negative values so that we allow unlimited short selling of the stock and cash bond. we have a right (but not an obligation) to buy a unit of the stock by paying a predetermined price K. A portfolio 7c = (~b. 0') and write ~ = ~' if f0 qS(s)ds = J~ qT(s)ds and f0 O(s)ds = f~ O'(s)ds for all t E [0. (49) An intuitive meaning of a self-financing portfolio is that t h e c h a n g e in its value depends only on the change of asset prices. a. (50) L e t X be a nonnegative ~ r . we say that a portfolio ~ = (~.m e a s u r a b l e r a n d o m variable. the number of units) of the stock and the cash bond we hold at time t. We call it apayoffor a claim. (ii) V~(t) >_ O. (31) of Section 2. Let S ( t ) = e rtS(t) and V~(t) = e-rtV~(t) so that S(t) and V~(t) are the discounted stock price and the discounted value of the portfolio at time t. = (0(t)) such that s)[2ds + /0 10(s)[ds < ec. T]. By a strategy or portfolio.e. by v(t) = 4)(t)s(t) + O(t)B(t) We identify two portfolios rc = (~b. respectively.. It is given explicitly by . F o r a given p a y o f f X . a. the solution Y(t) in (32) coincides with S(t) in (46).

(55) where log(x/K) + (r + a2/2)0 dl= d2 d l . the aritrage price of the option at time t is given by E*[e (r '). The reason is as follows: If we make a contract to receive the payoffX at maturity T and if we buy this contract by paying price v at time 0. Conversely. Its value V=(t) at time t is given by V~(t) =E*[e r(r-t)"Xlgt]. In particular.900 S. and hence. Let X be a payoff and assume that it is integrable under P*. Thus. is given by ~Po(x) = xN(dl) . V~(0)=E*[e rr. the arbitrage price of the option given by (52) can be computed explicitly from (46) and (51). then. then the buyer of this contract makes a short selling of the replicating portfolio for X thus gets a gain V~(0) .(t) in this theorem is called the arbitrage price at time t of the payoff X at maturity and V~(0) arbitrage price of the p a y o f f X at maturity. (S(T) . 0 > O. in particular. then (52) is obvious because e-rtV~(t) is a martingale under P*.a~/-0.V~(0). if ~ is a replicating strategy for X. In either case.v at time 0 and clear the short selling at maturity T by the p a y o f f X he receives.)(S(t)) . As for the proof of Theorem 15. Watanabe on THEOREM 15. if v > V~(0). for the European call option with the exercise price K. av/0 1 fa -t2/2 N(d) = --x/2~J~ e dt These formulas are known as the Black-Seholes option pricing formula. there is an opportunity of riskless gain (an arbitrage opportunity) for the seller or buyer. Then it is replicable and a replicating strategy 7c = (q~. (52) V. If v < V~(0). (54) Here.K ) + . only possible price we pay at time 0 to buy the contract without arbitrage opportunity is V~(0). the existence of a replicating strategy is .K)+l~a ] = '/*(r_.X] . more generally. the payoff is (S(T) . for an integrable payoff X.Ke-r°N(d2) . we remark the following.\$) f o r X is unique. it is given by E*[e (s(r)-K)+l = 'r(S0) (s3) and. the function ~o(x). the seller of this contract uses the replicating strategy ~ for X with the initial investment V~(0) to attain X and thus obtain a gain v .x > O.

for every smooth function f(t. dX] .. A more convenient probabilistic formulation of the model is given by D.S.X(t))dWk(t) + bi(t. Selected Papers.x) is symmetric and nonnegative definite. satisfies X i = (Xi(t)) c S. for details.d . 1996 and Baxter-Rennie. It6..j= 1..X( t) )dt. X ( 0 ) ) = M(t) + V(t) where M = (M(t)) C M c and V = (V(t)) E V c such that t 5 This is equivalent to saying that X = (X(t)). 1979).X(t)) . f(t.x) on [0. 1987). oc) × R d..e. Itd's stochastic calculus and its applications 901 essentially a consequence of Corollary 2 to Theorem 13. i.. the paper [2] in K.Xd(t)). Stochastic differential equations Stochastic differential equations (SDE's) were first rigorously formulated by K. i. k--1 .x) = aiJ(t.X(t) = (X 1(t). cf.. 1996..X(t))dt. the problem is to construct and analyze a probability model associated to this operator: The model is a diffusion process (a Markov process with continuous paths) whose system of transition probability densities is given by the fundamental solution to the heat equation ©~St = L t. Lamberton-Lapeyre.d . It6 in 1942..W.X(t))dt. 3.x) . dX/ = aiJ (t. Given a time-dependent differential operator 1 d 52 d Lt = ~ ~ = l a i ' ( t ' x ) ~ + i~=lbi(t'x)~ixi on R d where aiJ(t. Varadhan (Stroock-Varadhan.x)~(t. x))k= 1 is any system of functions satisfying F i Z %(t. k 1 then such X can be given in the form dXi(t) = ~ aik(t. dVx~(t)=bi(t. .f ( 0 . i r If (ak(t .. a continuous semimartingale. to construct diffusion processes corresponding to Kolmogorov's differential equations. Stroock and S. i = 1.R.. it is an Rd-valued continuous {~t}-adapted process X = (X(t)) defined on a probability space with a filtration {Yt} such that... (cf.

~t(W e) = p. (iv) the stochastic differentials dXi(t). . k = 1 .w)): [0. The equation we thus found for the stochastic differentials of the process X is exactly what we call It6's SDE. (ii) W = (W(t)) is an r-dimensional {~-t}-Wiener martingale. ec) x R d ~ R d @ R ~.1oo for i = 1 . (56)' Here.1.e..X) E ~2.... w(t)) by a Borel function a(t.w)= (c~(t. Watanabe where W(t)= (l/vl(t).x) : [0. . . the topological a-field). .X)dt .. .. i= 1. F o r each t _> 0. W~(t)). An important case of ~ E A e'r is when it is given as co(t. Let W d be the space of all d-dimensional continuous paths: W d = ¢g(I0. or equivalently. is an r-dimensional Wiener process with W(0) = 0.w)(s) = w(t A s). . the map W e ~ w Y(t.X)dW(t) + fl(t.X(t)) depend only on the present position X(t) of the system X = (X(t)). we consider the following SDE: F dXi(t) = ~ i k ( t .. Wr(t)) is an r-dimensional Wiener martingale. P) with a fil- tration {~-t} such that (i) x i = (xi(t)) E S for i = l .s. . X ) d W k ( t ) + fli(t.i = 1. .= the totality of d x r real matrices) which are ~([0. . In this case.X) E 5°1. d . 3. This equation is said to be of M a r k o v i a n type because the coefficients aik(t. SDE's based on Gaussian white noise (Wiener noise): The basic definitions We start by giving a general formulation of SDE's in which the coefficients may depend on the past history of the system. o o ) x W d .Xe(t)).d (56) k--1 or denote it simply in the matrix notation as dX(t) = ~(t.ioo((Wk(t))) and ~(t.X)dt. is a continuous Re-valued process and W = (W(t)). . (iii) ~(t.. . ~ is said to be independent of the past history or of Markovian type. X = (X(t)). .d. . satisfy the relation (56). . .. o c ) ) ® ~ ( W e ) - measurable and non-anticipating.r.. W(t) = ( w l ( t ) . .X(t)) and bi(t.d. s > o and let . Generally. oo) x W e with values in a Polish space S endowed with the Borel a-field 5~. w) = a(t.X(t)= ( x l ( t ) .. F o r a given c¢ E A d'~ and/3 C A d'~. w)) defined on [0. ~ .-1 (~(Wd)). w) E S is ~t(We)/5~-measurable. is called non-anticipating if. .. we say that a function F = (F(t.1oc is the totality of {~-t}-predictable processes f = 0r(t)) satis- fying fo [f(s)lds < oo for all t _> 0. oc) ~ R d) endowed with the topology of the uniform convergence on every finite interval (which is a Polish topology) and ~ ( W d) be the Borel a-field (i. where 2'1. . a. . for each t >_ 0. .. ..902 S.. define Pt : We -+ We by (p. A precise formulation is as follows: We say that X = (X(t)) is a solution to the SDE (56) if there exists a probability space (~.+ R e ® Rr(. Let A e'r be the totality of functions ~(t.

(59) Next. a(t. (58) can be transformed into an equivalent equation in the form of Stratonovich differentials: dX(t) = a(X(t) ) o dW(t) + b(X(t) )dt (58)' where r i g'(x) = b*(x) .. t >_ 0 . I f we consider a SDE as a machine which produces the solution as a output when we input a Wiener process.X)dW(s) + /0 t fi(s. Note also that when the coefficient o-(x) is sufficiently smooth.X)ds. the equation dX(t) = a(X(t))dW(t) + b(X(t))dt (58) is called a SDE of time-independent (or time-homogeneous) Markovian type. Here are basic definitions. we call X(0) the initial value and its law on R d the initial law or the initial distribution. ~7"~a~(x) ~ ( x ) . we see that. (57) can be made time-independent by adding one more component X°(t) = t to the solution X(t). c~(t. For a solution X = (X(t)) of SDE (56).X(t)) and b(X(t)) = b(t. if we would like to obtain the solution as a functional of the Wiener process.51 J=. setting { ~ t } to be the natural filtration of the pair (X(t).s <_ t. When we consider a SDE as a tool to construct a stochastic process. a. Itd's stochastic calculus and its applications 903 X(t) . then..u > v > t. There are two kinds of uniqueness.. As we shall see..x) = b(x). and the family of r a n d o m variables (X(s)..d . Furthermore.W(v). the uniqueness in law is sufficient. The law on . Since W is an {Yt}-Wiener process and X is {~'t}-adapted. w(t) ). if cr(t. this notion is closely connected with the notion of strong solutions. the notion of pathwise uniqueness is more natural and more important.x) and b(t. are mutually independent.e. if this independence property holds. X (t) )dW( t) + b( t . Conversely. uniqueness in the sense of law (uniqueness in law) and pathwise uniqueness. i= 1. a solution X is always accompanied by a Wiener process W.x) = a(x) and b(t. i.w)=a(t..w(t)) and /?(t. we can regard )?(t) = (t. Thus. To em- phasize this. W(s)). the Eq. When c~ and /? are of Markovian type. holds. the family of r a n d o m variables W(u) .X(t)). we define the notion of uniqueness of solutions. Note that the time-dependent Eq.s. W) itself a solution of (56). for each t > 0.~t}-Wiener process. X ( t) )dt (57) is called a SDE of Markovian type. w) = b(t.X(O) = f0 t ~(s. W = (W(t)) is an {~. in other words.X(t)) as a solution of time-independent SDE with coefficients #(X(t)) = cr(t.x) are inde- pendent of t. W(t)). we often call X a solution with the Brownian motion W or simply call the pair (X. the equation dX ( t) = ~( t .

(2) If the pathwise uniqueness for (56) holds and if a solution of (56) exists for any given initial law. i. 1989 and Kallenberg. (cf. Watanabe W a of X is called the law of the solutionX. i f X a n d X 1are any two solutions of (56) whose initial laws coincide. then X = F(x. then it holds that X(t) = X'(t) for all t _> 0. whenever X and X ~ are solutions of (56) defined on a same probability space (f~. Kallenberg.s. for each fixed t >_ 0 and x c R d. the continuous d-dimensional process X = (X(t)) defined by X = F(X(O). Y .s. X(0) must be a constant a.s. the m a p W~o ~ w ~ F(x. Watanabe and refined by O. W) is a solution of SDE (56) with the Brownian motion W. we have the following general facts due to T. W) a. w)(t) E R g is ~t(W~)/~(Rd)-measurable. the definition is equivalent to that in which we restrict solutions to those having n o n r a n d o m initial values. a. I f a unique strong solution F(x.w) E W d . 1996): THEOREM 16. then there exists a unique strong solution for (56). We give a more refined notion of strong solutions as follows. w ) ~ F(x.. Its converse is also true. also. This definition is equivalent to a seemingly less restrictive definition in which we restrict ourselves to solutions whose initial values are con- stants. the initial laws are 6-distributions at some points in R a. that is. Ikeda-Watanabe. where W~) = {w C Wr]w(0) = 0}.W) of SDE (56). P) with a same filtration { ~ t } and with a same {~t}-Wiener process W = (W(t)) such that X(0) = X'(0). it holds that X = F(X(O). Namely.s. for any solution (X.. (iii) Conversely.. Next. a. A solution X = (X(t)) of SDE (56) is called a strong solution i f X is adapted to the natural filtration {~-~} of the accompanying Wiener process W = (W(t)). It is obvious that the existence of a unique strong solution implies the pathwise uniqueness of solutions. We say that SDE (56) has a unique strong solution if there exists a function F : R d x W'~ 9 ( x . (1) The pathwise uniqueness of solutions implies the uniqueness in law of solutions. In this case..pW) (pW: the r-dimensional standard Wiener measure) with the initial value x and with the canonical Wiener process w = (w(t)) E W~). [~t(W~) = (ii) For any Ra-valued r a n d o m variable X(0) and an r-dimensional Wiener process W = (W(t)) with W ( 0 ) = 0 which are mutually independent. then the laws of X and X I coincide. Y a m a d a and S. For a strong solution X.e. we say that the pathwise uniqueness of solutions holds if. with the following properties: (i) F is Borel-measurable and. w) itself is a strong solution of SDE (56) realized on the r-dimensional Wiener space (W~. We say that the uniqueness in the sense of law of solutions holds if the law of a solution is uniquely determined by its initial law. because of the Blumenthal 0-1 law for the Wiener process.904 s. w) exists. .N(W~).

ec) x W d.g. e. Existence and uniqueness results for solutions The first result for the existence and the uniqueness of solutions for SDE's was obtained by K./ ? ( t . w) and ~(t.V. It6. Selected Papers.x)l + Ib(t. w) are bounded and continuous on [0. Krylov discussed a class of SDE's of Markovian type with not necessarily continuous but Lesbegue measurable coefficients. we replace the path space W d by the space ~¢d which consists of all continuous paths w • [0.w)l _< f r ( 1 + Ilwl[t).oc if e < co. it is formulated as follows: Set W(T) = {w E Wdli[w]lr _< T}. The boundedness assumption can be relaxed to.w) -c~(t. The existence of solutions was discussed by A. then a solution of (56) exists for any given initial law. a constant Kr > 0 exists such that l~(t. w')l <_Kr(llw-w'llt). but exists only up to a time e. there exists a constant Kr > 0 such that [c~(t.. t~[O. A standard proof for this fact is to show the tightness on the path space W d of probability laws of approximate solutions obtained by Cauchy's polygonal method. w c W d (60) where Ilwllt =max0<~_<tlw(s)l. (62) . however. the solution is pathwise unique and the unique strong solution in the sense of the previous subsection can be directly constructed in this case. 1980). x E Rd . It6 in the case of SDE's of Markovian type under the condition of Lipschitz continuity of coefficients (cf.x) are continuous and satisfy: Io-(t. If the coefficients c~(t. t E [0.2. at which we have limtTe IX(t)[ -. 1987). w) . w. co) ~ R e U {A} (the one-point compactification of R d) such that w(t) = A for t >_ e(w) := inf{tiw(t) = A}. Skorokhod. Also. papers [2] and [12] in K. such a direct construction of solutions can not be applied and it is more convenient to discuss the existence and the uniqueness of solutions sep- arately and appeal to Theorem 16 above to obtain the unique strong solution. Such equations are necessary in stochastic control problems (cf. Then the limit process in law can be shown to a solution. T]. In the general non-Markovian equation (56). A well-known sufficient condition for the pathwise uniqueness is the local Lipschitz condition. (61) If these conditions are violated.w)l + I/~(t. w')[ + [/?(t. for every T > 0. He applied Picard's method of successive approximation to con- struct a solution.x)l <_Kr(1 + lx[).x) and b(t. t E [0. there are several equations which have unique solutions in law but have no strong solutions.w' C W ( T ) . Krylov. called the explosion time. In more general cases in which the coefficients are not necessarily Lipschitz con- tinuous. N. the condition that. it is sufficient to assume that a(t. In the case of Markovian equation (57). We can extend the notion of solutions to include such a case of explosions.V. in general. For each T > 0.T]. Now we consider the conditions for the uniqueness of solutions. a solution does not exist globally in time. Itd's stochastic calculus and its applications 905 3. T].

THEOREM 19.x' E B ( T ) (63) where B(T) = {x E Rdllxl < r}.x')l <_Kr(Ix-x'l). each adapted to the natural filtration of W.0. x. then a unique strong solution exists for (57). we may replace the drift coefficient b(t.s. T] for every T > 0. it is sufficient to assume that . If we assume further the conditions (60) and (61). if furthermore the condition (61) is satisfied. Ikeda-Watanabe. Under the Lipschitz conditions (62) and (63).x) .x) by a non-Markovian drift coefficient //(t. for each x.P w) with respect to the canonical Wiener process w = (w(t)). + Ib(t. and a given Wiener process W = (W(t)) with W(0) = 0.b(t.x' E B ( T ) .x) = ~/x(1 .x) = v/x V O.906 S. (56) and (57). a(t. .X)dt . then Xn converges uniformly in t E [0. a sequence of d-dimensional continuous processes Xn = (Xn(t)). 1 . In this theorem. (Yamada-Watanabe. 2 .X~ 1)dW(s) + /0 fl(s. x. then X = F(x.x) .l{0_<x_<a}..x) . . THEOREM 18. there exists a constant Kr > 0 such that I (t. Consider the case d = 1 and the equation of the Markovian type (57). n -. tc[O. respectively. to X = (X(t)) which is a strong solution of (56) with the initial value x.x) and b(t. then the unique strong solutions can be constructed directly by Picard's successive approximation: If we define. w) satisfies the same Lipschitz condition and the growth condition as (62) and (60). w) is the unique strong solution of (56).b(t. Typical examples of such a are. i. Hence.x) are continuous. Xn(t) = x + /0 ~(s. the pathwise uniqueness of solutions holds for Eqs. N(Wf)). w). respectively. . a. successively by Xo(t) = x. a(t.etc. 1979) Consider a Markovian SDE (57) and assume that coefficients a(t.Xn_l)ds .z')L <_Kr(Ix-x'l). 1989) Suppose that a is H61der-continuous of order 1/2 and b is Lipschitz continuous. If this construction is carried out on the r-dimensional Wiener space (W~. for every T > 0.e. as n --+ oc.x) . if fl(t. (Stroock-Varadhan. THEOREM 17.T]. we have the same conclusion as Theorem for the equation dX(t) = a ( t . X ( t ) ) d W ( t ) +/3(t. cf. (64) Then the pathwise uniqueness of solutions holds. Watanabe In the case of Markovian equation. 2 + Ib(t. and that the d x d- matrix .

we see by Theorem 10 that W ( t ) = VV(t).~.1.5.X(O) and M(t) = exp If0 t fi(s.( s ) . Itd's stochastic calculus and its applications 907 k=l ) is uniformly positive definite. beforehand./5). on the probability space (~2. Then the uniqueness in law of solutions holds. This theorem can be shown in the following way: Given a d-dimensional distri- bution #. we set up.X)[ 2 ds] .X)7(t. the case d = r.X)]dt for c¢(t. a(t.IV~.X(O) - /0 fi(s. . More generally.X)dW(t) + fi(t. d ~ .= Vt>0Yt. f fi(s. in general. 1982).6 can be used to show the existence and the uniqueness in law of SDE's in the following form dX(t) = dW(t) + fl(t. M(t) is an {~t}-martingale and we can obtain a new probability/5 on ((2.f0t ]fi(s.f f . As we saw in Section 2. a d-dimensional {Yt}-Wiener process X = (X(t)) with the initial distribution #.X) + c¢(t. Then a solution of (65) exists for any given initial distribution and the uniqueness in the sense of law holds. Assume that fl(t. on a suitable probability space (g2.w)C A r'l.w) C A d'l is bounded.X)dt .X)dW(t) + [fi(t. the pathwise uniqueness does not hold.X).e. THEOREM 20.o¢(t. Then. The change of drift (Maruyama-Girsanov transformation) of Section 2. the the existence and uniqueness in law of the equation dX(t) = e(t.X)dVg(s))(t) = ~V(t) - 2 fi(s. w) = I: d x d identity matrix. f l ( t . However. if we can show. W) is a solution to Eq.X)dt . ~ ) by the M a r u y a m ~ G i r s a n o v transformation. Barlow (Barlow. P ) with a filtration {fit} such that ~. w ) c A d'l and bounded 7(t.X)ds = X(t) . Set ~V(t) = X(t) . Any solution can be obtained in this way and hence. (65) i. we can deduce by the same method the existence and the uniqueness in law of the equation dX(t) .w)E A a'r. the uniqueness in law holds. (65).X)ds is {fft}-Wiener martingale so that (X. a counter example was given by M..

B A) = a ( B A ( A ( t ) ) ) = a(B(t)) and hence the Eq. \ ti+l-ti+2 /~ . . 2 . X ( t ) )dW(t) . (67) along each sample path of B = (B(t)). and O(x) = x . we consider the following equation for a continuous strictly increasing function A = (A(t)) with A(0) = 0: A(t) = 1 ds. if a(t. 1989) If. 1989. there exists one and only one continuous function A = (A(t)) which satisfies the Eq. the existence and the uniqueness in law for the SDE dX(t) = a(X(t) )dW(t) holds and a solution is given by X ( t ) = B(A -1 (t) ) with A(t) = . by BA(t) = B ( A . Watanabe Cf. Given a one-dimensional Brownian motion B = (B(t)) with a prescribed initial law # on R. . t> 0 (67) le(A(s).+l)-W(. More generally. (Ikeda-Watanabe. (67). The time change of Section 2. t_>t0 a n d t = 0 fi(t.BA)I 2 where B A = (BA(t)) is defined. if e(t. (65) does not hold in general: Indeed. The pathwise uniqueness of solutions for the Eq. t _> 0 has the unique solution A for every sample path of B and hence the SDE dX(t) = a ( t .~o~ tn = 0. Furthermore. < t n < t . "'" where {tn} is a sequence such that 0 < .4 can be applied to solve a class of SDE's.I ( t ) ) . Tsirel'son gave such an example of fi(t.w) for some constants 0 < C1 < C2.5.i+2)~ t e [t/+l ti). Let d = 1 and consider an equation of non-Markovian type: dX(t) = c @ . for almost all sample paths of B = (B(t)). t H A-l(t) being the inverse function of t ~ A(t). the uniqueness in the sense of law holds for SDE (66). For a simple example.w)l2 _< C2 for all (t. Consequently.w) = O(W(. then the equation A(t) = 1 2 ds. w): 0. then c~(A(s). w) = a(w(t)) by a function a(x) on R. Thus.x) is Lipschitz continuous in t.w)~(t.Ix] is the decimal part of x c R. then X = B A = (BA(t)) is a solution to SDE (66) with a certain Wiener process W.w)* = Ic~(t. (67) has the unique solution A ( t ) = f~ la(B(s))l-2ds. the problem of the unique existence of solutions for (66) is reduced to the problem of the unique existence of solutions for the Eq. Ikeda-Watanabe. as in Section 2. 1 <'"<t0=l and lim. B. THEOREM 21.908 S.w) satisfies that C1 <_ e(t.1~ la(B(s) )l-Z ds. 1 .. X ) d W ( t ) (66) where ~(t. i = 0 .

w) = a y + w(s))ds where y E R is a constant. 3. d ~ ) = ds. ~ z ) be a measurable space and n(d~) be an infinite and a-finite measure on (S. (68) o . ~ . Nz). We can consider. Nz) with compensator Np(ds. The Eq. the solutions are necessarily continuous processes. In this way. A more interesting and nontrivial example is the case of e(t.P.footf(X(s))dsldW(t) can be solved uniquely in law and a solution is given by X(t) = B(A -1 (t)). (67) is now t ( I'A(s) x~-2 A(t) = f a y + \ Jo f(BA(u))du) ds which can be solved uniquely.3. as A(t) ~ta(y+~-l[foSf(B(u))dul) 2ds where x--+ ~b-l(x) is the inverse function of x--+ ~b(x)= foa(Y+z)2dz. an r-dimensional {Yt}-Wiener martingale W = (W(t)) and an {Yt}-Poisson point process p on (ff. Then W and p are necessarily mutually independent. t 4)) be a ~ ( R d) ® ~z-measurable function R d x S---+ R d such that the following growth condition is satisfied for some constant K > 0: I~(x)12 + [b(x)12 + Z If(x. Nisio. Here we formulate a Markovian type SDE only. 4) = (f(x. Let (S. by a Wiener process. Then the solutions are usually discontinuous processes. We can consider more general SDE's which are driven by a Poisson random measure as well as a Wiener process. b(x) = (bi(x)) be a Borel function R d --+ R d a n d f ( x . This example was given by M. for each given sample (B(s)) of B. n(d~). Itd's stochasticcalculusand its applications 909 has a unique solution in law given by X(t)= B(A-1(t)). SDE's based on Gaussian and Poissonian noise So far we have considered SDE's driven by a Gaussian white noise or. We fix ~0 c Nz such that n(S \ So) < oc. P ) with a filtration { ~ t } . on a suitable probability space (f2. w) given by ~(t. the equation dX(t) =a[Y+. equiva- lently. For such equations. x E Rd . f(x) is a locally bounded Borel function on R and a(x) is a bounded Borel function on R such that a(x) >_c for all x for some constant c > 0. Let a(x) = (a~(x)) be a Borel function R a --+ R d ® R r. Yershov. This fact was first remarked by M. ~)12n(d~) _< K(1 + Ix[2).

) . denoting by Px the law on "~(a of a solution X = (X(t)) with X(0) = x. ~-. dX(t) = a(X(t) )dW(t) + b(X(t) )dt .~)12n(d~) < K l x . Nz) with the compensator ds.) .. (70) o then.. (Ikeda-Watanabe. d~) = Np(ds. 1989) If a(x). such that X is { J r } - adapted and satisfies the Eq. P) with a filtration {~-~}.. By a solution of the Eq. P) with a filtration {•t}. (69) Here. d~) . W a t a n a b e Consider the following SDE: xi(t) = x i ( 0 ) + k=l 0 aik(X(s--))dWk(t) + f . there exist a unique {~-t}-adapted solution X of SDE (69) with initial value X0. THEOREM 22.yER d .) .1oc((Wk(t)) and f i ( X ( s .Np(ds. ~ ) " lz\z0(~).b(y)l 2 +{ [f(x. b(x) and f(x. Np(ds.d . 3) satisfy.0' bi(X(s-))ds + . £ f i ( X ( s .Np(ds.5. 3.~(y)l 2 + Ib(x) . on which there are given an r-dimensional {~'t}-Wiener martingale W = (W(t)).(X(t)) defined on a probability space (O. we see by (68) that (a~(X(t-))) E 5¢2.4. i= 1. on which there exist an r-dimensional {~t}-Wiener martingale W = (W(t)) and an {~t}-Poisson point process on (E. Nz) with the compensator ds-n(d~) and a d-dimensional W0-measurable random variable X0. 4) c Fp2~1°c so that the inte- grals in the right-hand side of (69) are well-defined as c/tdlfig processes. an {~t}-Poisson point process on (E. Since f~ IX(s)]2ds < e~ for all t > 0. SDE's and diffusion processes Consider a time-independent Markovian type SDE (58) with continuous coeffi- cients on Ra. the following Lipschitz condition for some constant K>0: I~(x) .Y [ 2. ~ ) " ls0(~). (69).ds-n(d~) . x. besides the growth condition (68). (69). d~) = Np(ds.n(d~).L '+ .910 S. (58) Then a solution admitting an explosion always exists. we mean an Rd-valued cfidlAg process X .~)-f(y. the system {Px} defines a diffusion process . Np(ds. Y. d~) + f i ( X ( s . d~) . Assume further that the uniqueness in law of solutions holds for (58). on any probability space (O. as in Section 1.. Then. d~).

Itd's stochastic calculus and its applications 911

(a strong Markov process with continuous paths) on R d with the point at infinity
A as a terminal point. Set

aiJ(x) = ~ ak(x)~(x),
i " i , j = 1,...,d
k--1
and define a second-order differential operator A by
1 d ~ ~ d
A = 2~i,j-I aij(x) ~iXi~Xj @ ~ bi(x) ©X," (71)
","= i~ l t

with the domain Cg(R d) (the space of all cg2-functions on R d with compact
supports). We set always f(A) = 0 for f C Cg(Rd).
By It6's formula applied to a solution X of (58), we have for f E C2(Rd),

f(X(t)) -I(X(O)) = Z ~-5~(X(s))~k(X(s))dW (s)
i=1 k=I dO tz+i

+
/0 (Af)(X(s))ds .

Hence, f ( w ( t ) ) - f ( x ) - fo(Af)(w(s))ds is a martingale under Px for every
f c Cg(Rd) and this property characterizes the diffusion process {Px}. The
diffusion {Px} is generated by the differential operator A in this sense. Further-
more, if for some 2 > 0, (2 -A)(C~(Rd)) is dense in Coo(Rd): ( = t h e closure of
C2 (R a) under the supremum norm), then the transition semigroup of the diffusion
is a Feller semigroup (a positive contraction and strongly continuous semigroup)
on C~ (R d) and its infinitesimal generator/1 in Hille-Yosida's sense is the closure
of (A, C2(Rd)). In particular, u(t,x) = E~[f(w(t))] for f C C02(Rd) is the unique
solution of the evolution equation
du(t)/dt = Au(t), u(O) = f .
Ifc(t,x) is continuous and v(t,x) is sufficiently smooth in (t,x) on [0, ec) × R d,
then by It6's formula, we have for a solution X of (58) with X(0) = x,

v(t,X(t))exp{fotC(s,X(s))dsl -v(O,x)

explfSc(,,X(z))drl ~V (s'X(s) )ak(X(s)
"~ixi i ) " dWk(s)
i=1 k ~ l 0 LJo /

+ /o'exp [/0sc(%X(v))dr )
. ~ + (A +c) (s,X(s))ds .

The first term (denote it by M(t)) in the right-hand side of this equation is a sum
of stochastic integrals by Wiener processes so that it is a local martingale. Hence,
if an {Yt}-stopping time T satisfies E({M)(T)) < oc, then we have E N ( T ) ] = 0

912 S. Watanabe

by Doob's optional stopping theorem. If, for example, v satisfies the heat equa-
tion
8v
8t + (A + c)v = O ,
we have from this that

v(O,x) = E{v(T,X(T))exp[fo~C(s,X(s))ds] } .

This formula can be used to obtain the probabilistic representations, in terms of
the diffusion X, of solutions for initial or boundary value problems related to the
operator A. On these topics, cf. e.g., Friedman, 1975.

3.5. SDE's and stochastic flows of diffeomorph•ms
Consider again the SDE (58):
dX(t) = a(X(t) )dW(t) + b(X(t) )dt . (58)
We assume that coefficients o- and b are smooth; we assume here that they are (g~o
with bounded derivatives of all orders > 1, for simplicity, although a more refined
result may be stated which depends on the order of regularity of coefficients.
Under this condition, the unique strong solution for (58) exists, that is,
on the r-dimensional Wiener space (W~,~(W~),Pr/), there exists a family
{X x = (X(t, x; W))}xeRd of Rd-valued continuous processes where X x is the unique
solution of the SDE (58) with initial value x and with respect to the canonical
Wiener process w E W~. Thus, we obtain, for almost all w E W~, the map

[0, o~) × R ~ ~ (t,x) ~ x ( t , ~ ; w ) ~ R ~
If we consider this as a map

Rd ~ x ~ [t H x ( t , x ; .)] c w ~ ,

then it induces the law P~ on W a. As we saw in Section 3.4, the system {P~} is the
diffusion process generated by the operator A.
If we regard it as a map

[0, ~ ) ~ t ~ [~ ~ x ( t , x ; )1 ,
then we have the following important result due to J.-M. Bismut and H. Kunita
(cf. Kunita, 1990):

THEOREM 23. With probability one, for all t >_ 0, the map [x ~ X ( t , x ; . ) ] is a
diffeomorphism of R d. Furthermore, introducing a natural topology on the group
G formed of all diffeomorphisms of R d, the map

is continuous, a.s.

Itd's stochastic calculus and its applications 913

The continuous process with values in the group G, thus obtained from the
solutions of SDE (58), is called the stochastic flow ofdiffeomorphisms associated to
SDE (58). The above theorem may be regarded as one of the most refined results
concerning the dependence of solutions of a SDE on its initial values. The
dependence on initial values of solutions has been studied from the beginning of
SDE theory mainly by Russian and Ukrainian schools; by Yu. N. Blagovescen-
skii, M.I. Freidlin, I.I. Gikhman, A.V. Skorokhod, among others.
As an application, we can show that the function u(t,x), t > O, x E R d, defined
by u(t,x) = EW[f(X(t,x, w)], f C C02(Rd), is (~2 inx and satisfies ~u/at = Au where
A is the differential operator (71).

3.6. SDE's and the Malliavin calculus
We consider the same SDE (58) under the same conditions on coefficients as in
Section 3.5; the coefficients are cg~ with bounded derivatives of order _> 1. Also,
we consider the solution X ( t , x ; w ) of (58) with initial value x realized on the
Wiener space ( W ~ , 2 , P w) where Y is the completion of ~(W~) with respect
to pW.
Since t -+ f ( X ( t , x; w)) - f ( x ) - f o ( A f ) ( X ( s , x; w))ds is a martingale under pre
for f c C~ (R d) (the space of all ~ - f u n c t i o n s on R a with compact supports), we
have

EPe[f(X(t,x;w))] = f ( x ) + EW{(Af)(X(s,x;w))]ds .
/0 '
This relation implies that the transition probability P(t,x, dy) --
p W ( x ( t , x ; w ) E dy) is, for each x, a distribution solution of ( 8 / © t - A * ) p = 0
where A* is the adjoint operator of A. Hence if the operator ~ / ~ t - A* is hy-
poelliptic, we can conclude that P(t, x, dy) possesses a smooth density p(t, x, y) by
appealing to the theory of partial differential equations. We can also discuss this
problem probabilistically by applying the Malliavin calculus to the solution
x(t, x; w).
The Malliavin calculus is an infinite dimensional differential calculus for
PW-measurable functions, i.e., Wiener functionals, on the Wiener space
(W~), ~ , pW). Since the space W~ is a linear topological space by the topology of
uniform convergence on finite intervals, we can consider the (Fr6chet) derivative
for functions defined on W~) in the direction of an element in W~. However, the
Rd-valued Wiener functional w H X ( t , x ; w ) for each fixed t _> 0 and x E R d is
not differentiable in this sense, in general; it is not even continuous, in general,
or, what is worse, it is not a function on W~ in a naive sense but is an equiv-
alence class of functions on W~ coinciding each other PW-almost everywhere so
that we can not even define its value at each specified point of W~. An important
discovery of P. Malliavin is that, nevertheless, these Wiener functionals can be
differentiated as many times as we want so that they may be called smooth if the
notion of derivatives is modified suitably: Firstly, we restrict the directions of
derivatives to be in the Cameron-Martin subspace H of the Wiener space W~.

in other words. this formal expression can be rigorously defined as an element in D -°~ if F satisfies the following conditions: (i) F E (D~) a. having the derivatives of all orders in this sense and.. . h c H. A typical example of generalized Wiener functional is given by a formal ex- pression 6y(F(w)) where 6y(. We denote it by D . these deriva- tives having the moments of all orders with respect to the Wiener measure.914 S. It should be remarked that a test Wiener functional is not necessarily continuous. as the Schwartz distribution derivative in the usual analysis for functions on a Euclidean space.) is the Dirac delta-function on R d with the pole at y E R d and F is an R d -valued Wiener functional. i. Secondly.F d) with F i C D °e for i = 1. there exists a test functional which can not be made con- tinuous on W~ by any modification of its values on a PW-null set. each of its d-components is in the test functional space. In the frame of the Malliavin calculus. F = ( F 1 . the Sobolev imbedding theorem on a Euclidean space no longer holds on Wiener space. equivalently. i. Here CrF(W) = ((OFi(w). Under the condition (i) above.e. Watanabe Here. . is denoted by Doe.. the notion of generalized Wiener functionals or distributions on the Wiener space: We introduce a natural topology on the space Doe (by means of the family of Sobolev-type norms defined on it) and then consider the topological dual. the space of all continuous linear functionals on Doe. the derivative is defined in a similar way as the Sobolev weak derivative. i.d. the Cameron-Martin subspace H is a Hilbertian subspace of W~ defined by H= hEW~l~hEL2([0.h)H.w) for each fixed t _> 0 and x E R d is in the space (D~) d. where DFi(w)[h] is the derivative of F i in the direction of h E H and (% ')~r is the H-inner product.x.e. We can define.j and aF(W) is nonnegative definite for PW-almost all w. . Malliavin's first important remark is that the Rd-valued Wiener functional X(t.~)-~Rr>-. The class of real valued Wiener functionals. ..e. oc)~Rr). (DFi(w). Ih(s)] ds . . DfJ(w))•) and Ofi(w) is an H-valued Wiener functional uniquely determined by DFi(w)[h] = (DFi(w). in the same way as the Schwartz theory of distributions on a Euclidean space. h(t)= h(s)ds with the norm 1 IlhliH = lihllL2ctO. .DFJ(w))H c Doe for all i.~ and call its element a generalized Wiener functional. (ii) F is non-degenerate in the sense of Malliavin that [det ~F(w)] 1 has moments of all orders with respect to pW . furthermore. We call Doe the space of test Wiener funetionals on the Wiener space. OfF(W) is called the Malliavin covariance of F. indeed..

= Z k = 1 . ..y) E (0. then the coupling of ~ E Lp c D . .~ against • c D °° is exactly the expectation by the Wiener measure pW of the product ~g. A more delicate condition can be given in terms of Poisson brackets of vector fields d ~ . ~.~ k=l ~ axj which corresponds to the H6rmander condition for the hypoellipticity in the theory of partial differential equations. This coupling is called a generalized expectation of 6y(F(w)). Cf. which is now an integrable Wiener functional. t > O. i=1 Vo(x)= ~ bi 1 i=1 .x. We know that the solution X(t.x. when a Wiener functional ~ is pth power in- tegrable for some p > 1. we can show that PF is ~oa and this coincides with the density of the law of the Rd-valued Wiener functional F.w) is the ellipticity of the operator A. on these topics. then the generalized expectation p(t.w))]. 1985. w) of SDE (58) satisfies the condition (i) above for all t > 0 and x c R d. If we can show that it also satisfies the condition (ii) for t > 0 and x c R d.y) thus obtained is the density of the transition probability P(t. r. The notion of generalized expectations indeed generalizes the notion of the Wiener functional expectations.e. the Malliavin calculus provides us with an efficient probabilistic method to study the existence and the smoothness for the density of laws of Wiener functionals and also the smoothness of conditional expectations. Kusuoka-Stroock. . ~) (i.. is a test Wiener functional and the generalized expectation PF(Y) := {6y(F(w)). Ira's stochastic calculus and its applications 915 Suppose that an Rd-valued Wiener functional F satisfies the above conditions (i) and (ii) so that 6y(F(w)) is well-defined as an element in D oo. . p(t. ~ and is denoted by EWI6y(F(w) ) . ~ ) × R d × R d. A generalized expectation EW[6y(F(w)) • ~b] for a test Wiener functional • is also c ~ in y and this coincides with EW[~b(w)IF(w) = Yl •PF(Y). det[a ij](x) > 0. 1) = EW[cSy(F(w)] is well-defined.y) =EWlby(X(t. the value of the linear functional at ¢~)is well-defined for (b c D °°. denoted by 1.x.x. dy) and. Then the coupling (6y(F(w)).e. i. is a fundamental solution to the parabolic partial differential equation 8u/Ot = Au. A simple sufficient condition for the nondegeneracy condition (ii) of the Malliavin covariance of X(t. ~)] .x. By the Malliavin calculus.x. In this way. x E R d is well-defined and defines a ~°~-function of (t. The Wiener functional taking the constant value 1. at the same time..x.

m i n { ( X ( 0 ) + W(s))A 0} .7. 1989 and W a t a n a b e . cf. 0<s<t q~(t) = . with probability one.e.. fo t l {o} (X(s) )d4(s) = ¢( t) for all t >0 . O<_s<_t These formulas for the reflecting Brownian m o t i o n and its local time were first obtained by P. 1997. 4o 2e J0 ~b = (~b(t)) is called the local time at x . Malliavin. oc) and a continuous increasing process q5 = (~b(t)) which satisfies the p r o p e r t y (iii) above and the S k o r o k h o d equation (72). 3. oe). 1948). It is easy to find explicit forms of X and qS: X(t) = X ( 0 ) + W(t) . co) and ~b = (~b(t)) is given f r o m X by 1 t q~(t) = l i r a . 1983. ~b) of a continuous process X = (X(t)) on [0. there exists a unique pair (X. Watanabe F o r a general account on the Malliavin calculus. Skorokhod equations and reflecting barrier diffusions Let X = (X(t)) be a one-dimensional Brownian m o t i o n and define a continuous process X + = (X+(t)) by X+(t) -.0 of the reflecting Brownian m o t i o n X. This diffusion can also be obtained as a unique solution of the following equation introduced by A. (ii) W = (W(t)) is a one-dimensional Brownian m o t i o n with W(0) = 0 which is independent of X(0). (iii) ~b = (q~(t)) is a continuous. X = (X(t)) is a reflecting Brownian m o t i o n on [0. THEOREM 24. i. t>0 .min {(X(0) + W(s)) A 0}. oe)-valued r a n d o m variable X(0) and a one-dimen- sional Brownian m o t i o n W = (W(t)) with W(0) = 0 which are mutually inde- pendent.V.IX(t)l. I k e d a .2¢l(X(s))ds.. X + is a diffusion process on the positive half line [0.W a t a n a b e . . oc) with the transition probability +expE It is called the reflecting Brownian motion on [0. Skorokhod: Consider the equation X(t) = X(O) + W(t) + ~(t) (72) where (i) X = (X(t)) is a continuous process on [0. L6vy (L6vy. e. Given a [0.916 S.f l[o. ~b(0) = 0 and t ~ qS(t) increases only on such t that X(t) = 0. Then. cx~). increasing process such that..g.

Consider the Skorokhod equation in D = D U OD: X(t) = X(O) + W(t) + /0 ' n(X(s))dO(s) (74) where X(0) is a / ) .x)= Ex~f(w(t))] is characterized by the solution to the initial and boundary values problem: ~u 1 ~u St-2Au inD. X is called an obliquely reflecting Brownian motion in D in the direction n(x) of reflection at the boundary.b}(X(s))d(o(s) = ~b(t) for all t _> 0. In the same way as Theorem 24. We can show the exis- tence and the uniqueness of solutions for a given independent pair of X(0) and an r-dimensional Wiener process W if a and b satisfy the Lipschitz condition i n / ) . If n(x) is the normal vector at each boundary point x E ©D. i. Next. X is called a reflecting Brownian motion on I.v a l u e d continuous pro- cess. ..v a l u e d random variable and W = (W(t)) is a d-dimensional Wiener process with W ( 0 ) = 0 such that they are mutually independent. First. Itd's stochastic calculus and its applications 917 The Skorokhod equation can be considered on more general domains. ~D The Eq. ~b = (qS(t)) is a continuous increasing process with qS(0) = 0 and J0 l{a. then X is called a reflecting Brownian motion. X and ~bexist uniquely.s. X = (X(t)) is a continuous process on I. for given X(0) and W. then the system {Px} defines a diffusion process on /) generated by the differential operator A/2 (A: Laplacian) and the boundary condition ~u/~n = 0 in the sense that the transition expectation u(t. X and q5 exist uniquely for given X(0) and W. n(x) is a non-tangential and inward-pointing unit vector. a. (74) can be further extended to the following SDE: We write it in the equivalent form using stochastic differentials. for x E ~D. The solutions of (75) define a diffusion process o n / ) which is generated by the differential operator A given by (71) and the boundary condition ~u/~n = O. IfPx is the law of a solution of (74) with X(0) = x. The increasing process 4) has the same meaning as above. we consider the Skorokhod equation in the multidimensional case. W = (W(t)) is a one-dimen- sional Brownian motion with W(0) = 0 which is independent of X(0). b]. ~b is a continuous increasing process with ~b(0)=0 and satisfies fo leD(X(s))dO(s) = ~b(t). Let D be a domain in R d with a @-boundary ~D and let/7) ~ x ~ n ( x ) ~ R d be given such that it is @ and. ~ =0. dX(t) = a(X(t))dW(t) + b(X(t))dt + n(X(t))d(o(t) (75) where a(x) : / ) --+ R d ® R r and b(x) : / ) --+ R a are continuous functions.e. consider the case of finite interval I = [a. and X = (X(t)) and 4 = (~b(t)) are such that X is a / ) . qS(t) increases only on such t that X(t) = a or X(t) = b. Again. a < b. Then it is given by X(t) = X(O) + W(t) + c~(t) (73) where X(0) is a random variable with values in I. ult=0 = f ..

There are many works on SDE's for diffusion processes in domains with more general boundary conditions than reflections (cf.g.½a(t)b(t)]M(t) dt . t c [0. d(M(t)X(t)) = b(t)M(t) o dW(t) + [d(t) . dW(t) + [d(t) .. to). b(t).8. e.~al2(t)] dt} and hence. to). 1989. Lions-Sznitman. dX(t) = .. The case of .½a(s)b(s)]M(s) ds) . the solution X(t).X ( t ) M ( t ) -1 o dM(t) + b(t) . 1987 for extensions and refinements). Then M(t)-' o dM(t) = -{a(t)dW(t) + [c(t) . Watanabe The Skorohod equation in a multidimensional region was first studied by H. If. 1984 and Saisho. Ikeda-Watanabe.. to) . a(t) = 0 and X(O) is Gaussian random variable independent of W = (W(t)). Set M(t) = exp - { J0' a(s)dW(s) -- J0' C(S) -. ~a } 1 2 (s)] ds . 1988). in particular. then the solution X = (X(t)) is a Gaussian process. From this. with the initial value X(0) is uniquely obtained by X(t) = M(t) -1 (X(O)q. Examples (1) Linear and exponential diffusions Consider the following one-dimensional SDE: dX(t) = [a(t)X(t) + b(t)]dW(t) + Ic(t)X(t) + d(t)]dt where a(t). The equation is equivalent to that in the form of Stratonovich differentials: dX(t) = a(t)X(t) o dW(t) + [c(t) . c(t). dW(t) + [d(t) . t c [0. 1979. e.la(t)b(t)] dt . cf. i.½a2(t)]X(t)dt + b(t).e. 3.g. Takanobu-Watanabe. d(t) are deterministic call-functions of t E [0. Tanaka (Tanaka.½a(t)b(t)] dt .918 S.j[otb(s)M(s)o dW(s) + ~o't[d(s) . (0 < to _< oc) and W(t) is a one-dimensional Wiener process.

t ) . 1] for all t > 0. the unique solution exists for a given initial value.1 / ( t 0 . Note also that the Eq. By Theorem 18. oc) is known as the Bessel diffusion of dimension d. . b(t) .Y(t). for 0 < to < oc and y E R. It is well- known that. Let a = 2 and c = 0. ec) generated by the differential operator: d2 d A = axe+ (cx + d) The case of c = d = 0 has been considered by W. then 2 -. and. Itd's stochastic calculus and its applications 919 Langevin's equation. if X(0) E [0. a. is the SDE for the pinned Brownian motion. d be real constants such that a > 0 and d _> 0. oc) corre- sponding to the differential operator --x " This diffusion on [0.X(t))} V 0.O. 0 < t < to with the initial value x is a Brownian motion B(t) conditioned by B(0) = x and B(to) = y. (2) The square of Bessel processes Let a. oc) The case of a(t)=_0. for examples of such SDE's and their multi-dimensional extensions.tt and d(t) =_ O.s. cf. b ( t ) = 1.. then X(t) >_ 0 for all t _> 0.1.s. . the solution XJ°. a(t) =. 1951) in connection with a scaling limit of critical Galton-Watson branching processes. the radial motion of a Brownian motion on R d is a Bessel diffusion of dimension d. (3) SDE's related to genetic models Consider the following one-dimensional SDE: dX(t) = azv/{X(t)(a . c(t) = .s. c. a. c(t) . if X(0) > 0 a. By Theorem 18. and.O. b(t) . and consider the following one-dimensional SDE: dX(t) = (2aX(t) V o)l/2dW(t) + (cX(t) + d) dt . 1976. Sato. 1]. Thus.g..d(t) =. Feller (Feller. (7 > 0). oc). The solutions define a diffusion process on [0. e. is a typical ex- ample and the solution ( X ( t ) = e -'/t X ( O ) + /0' e 'lsdW(s is well-known as Ornstein-Uhlenbeck's Brownian motion. tE[O. the unique solution X(t) exists for a given initial value.s. If X = (X(t)) is the corresponding diffusion on [0..7 .8 is the case of a(t) = a. then X(t) E [0. 1] a. the solution defines a diffusion process on [0.(X(t)) defined by X(t) = X ~ is a diffusion process on [0. (48) for the Black-Scholes model of Section 2. c ( t ) = ..t ) and d ( t ) = y / ( t o . when d is a positive integer. This class of diffusions appears as scaling limits of M a r k o v chain models for gene frequencies in population genetics. dW(t) + c(X(t)) dt where c(x) is Lipschitz-continuous and satisfies that c(0) _> 0 and c(1) < 0.

Just as in the case of dy- namical systems. natural state spaces on which SDE's are to be con- sidered are manifolds: SDE's on manifolds provide us with basic tools in the probabilistic study of problems in analysis and geometry on manifolds. w(t) = ( w l ( t ) . the r-dimensional Wiener space (W~).. ~ . as our basic probability space. ~ ) ~ M) be the space of all continuous paths on M. we considered SDE's on a Euclidean space.e. pW) where ~. .2. Watanabe 4. . Suppose that we are given a system of cg~-vector fields A0.920 S. w r ( t ) ) .r. 4. . then X . respectively. let _~/= M tA {A} be the one-point compactification of M and WM be the space of all continuous paths on M with A as a trap. for any f C C~ (M) (:= the space of all cg°%functions on M with compact support.is the completion of ~(W~) with respect to pW. i. . We always consider SDE's based on the canonical Wiener process w = ( w ( t ) ) c W~. however.( X ( t ) ) is a solution of (76) if and only if X(t) = (X 1(t). When M is not compact. (77) where o is the Stratonovich differentials defined in Section 2. we adopt the usual convention for the omission of the summation sign. . a continuous semimartingale) and satisfies d f ( X ( t ) ) = (Agf)(X(t)) o dwk(t) + (aof)(X(t)) dt . A precise meaning of the SDE (76) is as follows. Throughout this section. SDE's on manifolds: The basic theory Let M be a connected a-compact cg°%manifold of dimension d and let WM = C([0.. f ( X ) = ( f ( X ( t ) ) ) c S (i.. . it is always the natural filtration of the canonical Wiener process. we s e t / ( A ) = 0 when we consider on ~/).A1.. we always take.Xd(t)).. (76) Here. we only consider strong solutions of SDE's so that. If Ak(x) = ak(x ~ . . in each local coordinate..e. w(t) = A for all t _> s if w(s) = A. Ar on M. is a d-dimensional continuous semimartingale and satisfies . k=l. We say that X = (X(t)) is a solution to SDE (76) i f X is an {Wt}-adapted continuous process on F / w i t h A as a trap. We write a SDE on M in the following form: dX(t) = Ak(X(t) ) o dwk(t) + Ao(X(t) ) dt . Stochastic differential equations on manifolds So far. and Ao(x) = bi(x) ~ i in a local coordinate.. When we speak of a filtration { ~ t } on the Wiener space....1. WM and W~2 are endowed with the topology of the uniform convergence on finite intervals and N(WM) and N(W~?) be the topological a-field on WM and W~2. such that..

coordinate-free) meaning because the Stratonovich differentials obey the usual chain rule.3.. Setting XX(t. Furthermore. There are two general methods to construct the Brownian motion on M using SDE's. i. Also. (78) has an intrinsic (i. 4.e.x. a diffusion process on M U {A} with A as a trap) is called a (minimal) Brownian motion on M if it is generated by AM/2 where AM is the Laplacian. .x.5. the diffeomorphic property of solutions as stated in the theorem can be deduced from Theorem 23 of Section 3. except on a set ofPW-measure 0. projection) on M of the stochastic moving frame over M which will be discussed in the next Section 4. A diffusion process on M (more precisely. w). x). 1957) and apply the result in the Euclidean case. w) such X(t. Laplace- Beltrami operator. The second method is based on the imbedding of the manifold: We imbed M into a higher dimensional Euclidean space R r so that the Riemannian metric on M is . Itd's stochastic calculus and its applications 921 dXi(t) : i o awe(t) + bi(X(t))dt : aik(x(t))" dwk(t) ÷ bi ÷ 2 k--1 "4 (X(t))dt (78) Note that the Eq. w)). defines a diffusion process on M which is generated by the second order differential operator A of the H6rmander type: 1 r A=~k~__IAZ+A0 . w) = (X(t.x.e. w) c M.2. X(t. the following holds: For each fixed (t. Brownian motions on Riemannian manifolds Let M be a Riemannian manifold. THEOREM 25. t 1 is a martingale under Px. The first method is to obtain it as the trace (i. x0. A Brownian motion on M exists uniquely: It is a family {Px} of probability measures on W~2 such that Px(w(O) = x) = 1 and. The form of the differential operator A can be deduced from It6's formula. x0. w) is a diffeomorphism between a neighborhood of x0 and a neighborhood o f X ( t . where Px is the law on W~ of It ~-+X(t. w) is an M-valued Wiener functional for each (t. (78) in each local coordinate and then putting these solutions together. for every f C C~ (M). and the system {Px}x~M. the map x ~ X(t. The unique existence of solutions can be deduced by solving the Eq.)].e. on M. xo. We can also imbed the manifold M in a higher dimensional Euclidean space by appealing to Whitney's imbedding theorem (Whitney. x. For each x E M. there exists a unique strong solution X ~ = (XX(t)) of (76) with X~(0) = x.

xi(t) Z X k ( t ) • dwk(t) k=l d -~. . using the imbedding M c R'. then we m a y consider that TxM C R r as a linear subspace and the Riemannian n o r m o f TxM is the restriction o f the Euclidean n o r m o f R r.A.. . 1 .Xd+l) E R d+l x k2 ~ 1 ..0.r .922 S. k = 1 . If we denote by Px the law on W~2 o f the solution X = (X(t)) of (79) with initial value x c M. . . i = 1 . ... S D E (79) can be solved as an S D E on Rr: we extend the vector fields A 1 . Let P(x): R r ~ ~ ~ P(x)[~] E rxM be the o r t h o g o n a l projection of R r onto TxM.. d + 1 .. N o t e that. . Then d+l ~ Ak(x) = Z(g)•i -. . by Ak(x) = P(x)[6k]. This construction o f the spherical Brownian m o t i o n is due to D.A~ to s m o o t h vector fields A 1 . i=1 Hence. .W.. . . Then A 1 . . the solution stays in M for all t > 0 and is irrelevant to the way o f extensions of vector fields. x E M. • . . Watanabe induced f r o m the Euclidean metric o f R r...0.. on R ~ and consider the S D E dX(t) = ~lk(X(t) ) e dwk(t) on R r. . If TxM is the tangent space at x E M of M.. 6~1 is the canonical base o f R~: k-th c~k=(0.. d + 1.. where [61.. Define & ( x ) ~ TxM.. . Stroock. ..xi(t)dt. As an example. . r. then the family {Px} defines the Brownian m o t i o n on M...xi(t) Z Xk(t) o dwk(t) k=l d+l : dwi(t) . . k=l.. . .0). consider the case o f the unit sphere S d imbedded in R d+l as Sd z x z (Xl. . ..At are s m o o t h vector fields on M and we can consider S D E dX(t) = A~(X(t)) o dw~(t) (79) on the r-dimensional Wiener space. If the initial value x is in M. if we consider the following S D E on R d+l defined on the ( d + 1)- dimensional Wiener space: d+l dXi(t) = dwi(t) .XkXi) ~Xi k = 1. then the solution X = (X(t)) stays on the sphere S d for all t > 0 if X(0) = x c S d and this solution is a Brownian m o t i o n on S d.. .

Stochastic moving frames Let M be a Riemannian manifold of dimension d and x c M. ed] of the tangent space TxM at x. i = 1 . 1999. Y(t)) defines the Brownian motion on H2 starting at (x. By a frame at x. . e = [ e l . . . we mean an orthonormal base (ONB) e = [ e l . 1 . dY(t) = Y(t)dw2(t) . For the Brownian motion on H2 and its applications.5. g) rg O(M) defined by r9 = r o g. Y(t)) with the given initial value (X(0). Itd's stochastic calculus and its applications 923 As another example. we consider a Brownian motion on the Lobachevskii plane. by dX(t) = Y(t)dwl(t). 6i = /-th ( 0 . x c M. complete. O(M) is called the bundle of orthonormalframes over M.e. . . e). Thus a frame r at x ~ M can be described as r = (x. . where r -. c. where O(d) is identified with the group of all isometric isomorphisms of R d. in R # to el. Gruet.~ dwl(s). Y(0)) = (x. is called the canonical isomorphism associated to the frame r. . e). . e = [ e l . . There is an important r a n d o m motion of frames which we call a stochastic moving frame over M. Then the Laplacian is given by AI-I2 = = yZ(~2/Sx2 + ~2/~y2).g. we see that the unique solution (X(t). Gruet. d. We take a plane R 2 and let w = w(t) be a Brownian curve in R 2 . . e).-C.y) c H2 is given by X(t) = x + g(s) dwl(s) = x ÷ y exp w 2 ( s ) . however. We can identify r C O(M) with an isometric isomorphism 7 : R d ~ TxM. we explain the idea in a simple case of M being a two dimensional sphere S 2. ed]. . . 1997 and Ikeda-Matsumoto. This notion can be defined precisely by means of SDE on the bundle O(M) of orthonormal frames. .). 0). The totality of frames at all points in M is denoted O(M). Y(t) = yexp[w2(t) .f. .(x. . as usual.y). defined by sending each of the canonical base 6i. ed]. the Lobachevskii plane or hyperbolic plane is a two-dimensional.. and by L. in Yor (ed. The projection re: O(M) -+ M is defined by ~(r) = x if r = (x. on two- dimensional Wiener space. Alili and J. .-C. . . Before giving a formal definition. 0 .2 ] " This (X(t). . 4. simply connected Riemannian manifold of constant negative curvature which we realize. By the result in Section 2. . 0. .3. by the upper half plane H2 = {(x. . papers by J.y)[y > 0} with the Riemannian metric ds 2 (dx 2 Av d y 2 ) / y 2. SDE for the Brownian motion is given. There is a natural right action on O(M) of the orthogonal group O(d): Rg : O(M) × O(d) (r. . Hence. N o w O(M) can be given a natural structure of manifold so that it is a principal fibre bundle over M with the structure group O(d). x = z(r). .

rg. As for the action of the orthogonal group O(d) on O(M). Then these bases at different points along the curve w(t) are parallel to each other. e(t) = [el(t).32] forms an ONB in the tangent space Tw(t)R2 ~. e={el. where x(t) is the geodesic on M with x(0) = x and ax It=0 = ei and e(t) is the parallel translate. the solution) r(t) on O(M) of the following ordinary differential equation on O(M) with the initial value r E O(M): dr(t) dt -Ai(r(t))... ..e(t)). N o w we role the sphere S2 on the plane R 2 along the Brownian curve w(t) without slipping. . r e O(M) . r. there is a notion of the system of canonical horizontal vector fields A1. where g lw E W d is defined by (g-lw)(t) = g l[w(t)]. r. r. Then the trace of w(t) together with the ONB 6 at w(t) is transferred into a curve x(t) on S 2 with an ONB e(t)--[el(t). the random curve x(t) thus obtained is a Brownian motion on the sphere S 2.e2(t)t in Tx(t)S 2.w)g=r(t. d. Let (W0d. 2 . the solution r(t) = (r(t. P v/) be the d-dimensional Wiener space.... r. e(t)) thus transferred is what we call stochastic moving frame over S 2. . r. we have for each g E O(d) (being identified with an isometric isomorphism on R d) that r(t. w)) of the SDE dr(t) = A/~(r(t)) o dwk(t) (80) on O(M) with the initial value r.. that is.. e2] in the tangent space TxS2 at x. .. w). A formal definition of the stochastic moving frame is as follows. Ai(r) is a smooth vector field on O(M) uniquely determined by the property that the integral curve (i. choose a point x c S 2 and an ONB e = [el. coincides with the curve r(t) = (x(t).1) so that 3 = [31. We assign at each point w(t)E R 2 the canonical ONB 3l = (1. w ¢ W := W~ endowed with the standard two- dimensional Wiener measure pW on W so that (W..e). Watanabe starting at the origin 0. w) = (x(t.r. w)]. r. The random curve r(t) = (x(t). by definition.Ad on the orthonormal frame bundle O(M): For each i = 1.P W) is the two-dimensional Wiener space. e(t.e. r(O)=r=(x. We put the sphere S 2 on the plane R 2 so that x touches at the origin 0 and the ONB e coincides with the ONB 3. r(t.R 2 at w(t). t > O.. In differential geometry. Suppose that the Brownian curve w(t) is traced in ink.. w)).ed(t)] .924 S. in the sense of Levi-Civita.. if x(t.0) and 32 = (0. ed] along the curve 4t).edl .g-lw). The stochastic moving frame over M starting at a frame r C O(M) is. t >O.. . of e = [ e l . .. w) = ~[r(t. In particular. Given a sphere S 2. Also.

r. it does not explode in finite time. r. the fundamental solutions to heat equations. Elworthy (Eells-Elworthy. g ~ O(d) . r. w)) E D ~ for every smooth function f on O(M). a. F o r each (t. t _> 0}. we consider on a compact Riemannian manifold M.r. that is. r. t > o} £ {x(t. Let r(t) = (r(t. t ~ o. w)) depends only on x = ~(r) so that we may write . Then. w) d x ( .e. as we saw in Section 3.6. for example. . i. 1989 for details.6. Itd's stochastic calculus and its applications 925 x(t. we deduce that {~(t. (82) In other words. r. 4. it is a Brownian motion on M. . depends only on x -. w E W0d be the stochastic moving frame over M as discussed in the previous section. w).g-lw). 1976) to realize an idea of K. we can define the formal expression by(X(t. w)l satisfies Prg = P.w) =4t. an im- portant role is played by the heat kernels. ~g. ~.s. for all g c O(d). r. since M is compact. Note that. w) is smooth in the same sense.4. r. Probabilistic representations of heat kernels by Wiener functional expectations In m a n y problems in analysis and geometry of Riemannian manifolds. Hence the M-valued Wiener functional X(t. ~ e O(M). Morse inequalities for Morse functions and so on. we discuss a probabilistic approach based essentially on SDE theory and the Mal- liavin calculus to obtain heat kernels by Wiener functional expectations. Ikeda-Watanabe. t > O. F r o m now on. 1] × o(m). Here. It6 on the parallel displacement of tensor fields along the Brownian curve (the paper [23] in It6. there are so-called heat equation methods used effectively in such problems as asymptotics of the eigenvalues of the Laplacian. and hence the generalized expectation EV/by(X(t. the law P~ on W~? of [t H x(t. 1987). r.~g. r) C [0. rg..To(r) so that we may write Pr ----Px. the Brownian motion on M can be obtained by projecting the stochastic moving frame over M. In this way. Atiyah- Singer index theorem. r E o(m). This implies that P. for sim- plicity. Cf.) Then. g c O(d) . it is non- degenerate in the sense of Malliavin (this notion can be defined similarly as in Section 3. Eells and D. ~ c O(M). the system {Px} defines a diffusion on M with A as a trap and we can show that it is generated by AM/2. Also for fixed t > 0 and r E O(M). The notion of stochastic moving frames has been first introduced by J. w)) as an element in D -°~ where by is the Dirac delta function with the pole at y ~ M. g ~ O(d) .. w) is a smooth O(M)-valued Wiener functional in the sense that f(r(t.K. r(t. w). w). we have x ( . Another important application of the stochastic moving frame will be given in the next section. (81) Since g lw ---- d w by the rotation invariance of Wiener process. w)). By (82).

r. i. r. . (86) From this expression of the heat kernel p(t. for i = 1 .x. . instead of (80)..y)... we con- sider the case of the exterior product of cotangent bundle over M so that its sections are differential forms on M. w))ds} of the Feynman-Kac type is in the space D °°..Vu .. .y) and study its short-time asymptotic properties (cf. Watanabe. . .l. w).. e. i. r.r. Here. By the same reason as above.e. .y) = EW~Sy(X~(1. we can deduce its regularity in (t.. w))ds}6y(X~(t. x. (84) If. .Afip. the fundamental solution to the heat equation Su 1 St . Let End(A R d) be the algebra of linear transformations on A Rd and let ai* E End(A R d) be defined by a~@) = (~i A )~. then we have. w). w) ) .w))ds}~y(X~(1. . Watanabe p(t.w)) 1 (87) defines the heat kernel for the heat equation with a potential: Su 1 St . t _> 0} and hence p(eZ.r. . (88) We now consider a heat equation on a vector bundle. it depends only on x = ~(r) and p(~2. if V is a smooth function on M. x. .x.2 Avu ./~6i~ to fi and fi~A.e. < i p < _ d .. Ikeda-Watanabe. . r. e d ] .2 AMU -.y) =EW[exp{-~2 fol V(x~(s. d and 1_<il < .r.)v ~ A Rd' i = 1 . a test functional. that {r( 2t. w)) ] is well defined. w) ) . .. 1990). we consider SDE with a parameter e > 0: dr(t) = eAk(r(t)) o dwk(t).g. r. /~ R d = ~pd=0 ® A p R d is the exterior product of R d which is a 2d-dimensional Euclidean space with the canonical basis 6i~/~ ""/~ 6/p. d . t _> 0} r.x. The canonical isomorphism "~ : R d ~ TxM naturally induces an isomorphism "~:Ra--+ Tx*M and an isomorphism 7: i ~ R d ~ A T~*M by sending bases 6 i = (~) and 6il A-.r. r(0) = r (85) and if we denote the solution by r~(t.fd] is the ONB in TxM dual to e = [ e l . . . for simplicity. where f=~.926 S. y) is the heat kernel. y) = EW6y(X(t.x. Furthermore. w). . (83) This p(t. 1988. by the scaling property of Wiener process. respectively. so that the generalized expectation EW Iexp{-e2 fot V(X~(s. then the Wiener functional exp{-e 2 f~ V(X~(s.

Airault-Malliavin. r. Hom(/d. .w))M(t)' M(O) = I . Thus we may set p@2. 1 . 1963.2 D2(J)(re(t'r. ( 1 .ajq . < ip <_ d.Az])r be the scalarization of the Riemann curvature tensor. Let JiJk1(r)= (o}([Ak. q = O.r. Here. r. Malliavin (Sugita.y) = 7. By a theory on a refinement of gen- eralized expectations in the Malliavin calculus (called quasi-sure analysis in the Malliavin calculus) due to H.) Let D2(J)(r) E E n d ( A R e) be defined by D2(J)(r) = jijkl(r)a*aja~al. By considering the action of O(d). we can assume that #(. Sugita and H. (89) Let 5y(X~(1. < jq < d.r.Eve [Me(l. on the space A(M) of differential forms on M: . Ar. d . . Airault-P.. which is a so(d)-valued 1-form on O(M) and {Ak} is the system of canonical horizontal vector fields introduced above.. r. w ) . forms a basis in End(ARd). . 1 <_j~ < . Kobayashi-Nomizu. (co = (co}) is the connection form for the Levi-Civita connection. w) by the solution to the following differential equation on End(A Re): dM(t) e2 dt . 1987. r. we deduce as above that it depends only on x = ~(r). w) be the stochastic moving frame as defined above by the solution to SDE (85) and define an End(fRd)-valued process M~(t.aipajla. Then the system ai~ai2 .. w)) be the generalized Wiener functional defined above and con- sider the following generalized expectation: 7E W[M~(1. . p .r. V2) stands for the space of linear transformations from F] to V2.x.2 .. w)-' 6y(X~(1. i. Cycon et al.. 1988. r. where 1 _< il < . r.w)M and 7: A Rd --+ A T*M are canonical isomorphisms defined above. cf. ~(1. we may assume that Xe(1.. w)~(1. r. Itd's stochastic calculus and its applications 927 Let ai be the dual of a*. . In particular. in general..w) Hom(AVM. r. w) = y in this expectation.ARd) and hence this generalized expectation is well defined and takes values in -om(Ar.. . w))] (90) and this kernel defines the heat kernel for the heat equation on the section F ( A T ' M ) of the exterior product bundle f T*M . w))] .. Let r~(t. 1988).w) : A Re --+ A Tx°('. r. cf.e. r.v) • Here.i. w) -~ 5y(X~(1.

w)]) . (92) k=l Then the solution with 9(0) = e exists uniquely and globally. as dg(t) = ~ g(t) " ak o dwk(t) + g ( t ) . g(s) -1 • g(t)) and {g(u).-M. g(t). g(s) -1 (resp.s ) are equally distributed. Then the SDE (92) can be written simply. EXAMPLE 1. The Lie algebra ~ of G is a Lie subalgebra of gl(d. Bismut (Bismut. Let A0. g(s) -1.. left-)invariant Brownian motion can be obtained in this way. (iii) for every t>_ s. The solution g(t) with g(0) = Ed (d x d identity ma- trix) is a left-invariant Brownian motion on G.g°(t.w). Ikeda-Watanabe. a system A0. R) or gl(d.Am be the system of right-(left-)invariant vector fields on G and consider the SDE on the r-dimensional Wiener space: r dg(t) = ~--~Ak(g(t)) o dw~(t)+Ao(g(t))dt . Brownian motions on Lie groups Let G be a Lie group. Then it is a right-(resp.e. 1984). 1989 and Watanabe.g(t)) and g ( t . The stochastic flow of diffeomorphisms t ~ [g ~ g(t. Watanabe Ou 1 a t = ~ Au (91) where A = .a1. The original probabilistic approach is due to J. k=l where w(t) is a N-valued continuous semimartingale given by #(t) = ~ = 1 wk(t)ak + tao.g] (resp.A1.. By identifying ~ with the space of all left-invariant vector fields on G in the usual way.at C ~. in the matrix notation. g.. We denote it by g°(t. the multiplication group of all d x d nonsingular matrices.. g(s) -1 (resp. i. a Lie subgroup of the general linear group GL(d. C). 9(t)... w)] defined by the solution of SDE (92) is given as t ~-+ [g~-+g°(t.Ax... (Linear Lie groups) Let G be a linear Lie group.( d * d + dd*) is the de Rham-Kodaira Laplacian acting on A(M).5. Cf. the algebra of all d x d matrices.. R) or GL(d. aodt = g(t) o d~(t) . 4. C). every right-(resp. .. .928 S. t~[g~g. left-)invariant Brownian motion on G and con- versely.Am of left- invariant vector fields is given by do. (ii) for every t > s. A stochastic process {g(t)}0<t<~ is called a right-(left) invariant Brownian motion on G if it satisfies the following: (i) with probability one.. w). u _ s} are inde- pendent. g(0) = e (the identity) and t ~ g(t) is continuous. 1990 for details and applications.

1 <_k < r. . Z(i~/) ~ X(ij) -]..z ) .Xk -1. . an algebraic area of two dimensional region surrounded by the Brownian curve (w 1 (s). 1 _< i < j < r . H2 is called the Heisenberg group.. .y. Xi(t)-o dwi(t). . for w(t) = (wl(t)..x(id)(t)).I(xiYj -. x(~. instead.Yk.w / (s) o d w i(s)l =~ [wi(s) . s0.Ar of vector fields on Hr by A0 = 0 and Ai(X)=~_~+ "-:=-'.. y(~. y E H~. x. the S D E (92)is given by dXk(t) = dwk(t). (Nilpotent Lie groups and L6vy's stochastic area integrals) Let r _> 2 be an integer and d = r(r + 1)/2. 1 < k < r. i. essentially due to L6vy (L6vy. 1948) and so it is called L~vy's stochastic area. writing g(t) = (Xk(t). then the solution g(t) with g ( 0 ) = E d is a right-invariant Brownian m o t i o n on G. A 1 . w.j)). W a t a n a b e .Y(i. The following formula. 01 In particular.x(i. 2 2 . L6vy (L6vy. Z(gd)). is very i m p o r t a n t in m a n y applications: cf. - The solution X ( t ) with Y(0) = 0 is given by X k ( t ) = wk(t). This notion has been introduced by P.g(t). Bismut. 1< i< j < r .r . r.g. y = (Yx. . w2(s))o<s<t and the chord connecting the initial and terminal points of the Brownian curve. Hr is a Lie group under the group multiplication z = x.wJ(s) • dwi(s)]. . k = 1 . w2(t)). . dXIiJl(t) ----xi(t) o dw](t) .j) -.j<l j. . . defined by Zk ~. 1 <_ i < j << r} . Set H~(~R d~R r xso(d)) :--{x= (xk.e. these are all right-invariant vector fields on Hr and. 1997: F o r a = (aij) c so(r) (:= the totality of r x r skew symmetric real matrices).j)). We define a system A o . for r = 2. intuitively.xjYi) where x = (xk. 1988. z = (Zk.j>i ~X(id) Then. . the S D E in the martix notation: dg(t ) = o d#(t). j..j)) . Itd's stochastic calculus and its applications 929 If we consider. EXAMPLE 2. and X (i'j) (t) = S (i'j) (t) := ~1 ~0 t [wZ•(s) o dw/(s) . It is called the f r e e nilpotent Lie group o f step 2 with r generators.1.. 1951). i= 1. e.z) denotes.dw/(s) .

cf. As a short introduction to stochastic calculus. Rogers-Williams. 1989. For approximation of solutions of SDE's by solutions of ODE's. t999.. 1981. 1980.. In statistical problems. 1990.930 S. Dellacherie. Important books on SDE theory published before 1980 are. or. that is. equivalently. 1976. 1995. Jacod-Shiryaev. cf. Bichteler. Jacod. (3) For applications of conformal martingales to problems in complex anal- ysis. Kloeden-Platen. E P[exp(ic~S(l'a)(1)lw(1) = 0)] . McKean. and many others. Tanaka. 1965.g. cf. 1989. Takanobu-Watanabe. For these. the discontinuities on the Wiener space of solution is essentially caused by the discon- tinuities of stochastic areas. 1987. For applications to stochastic control problems. Wong-Zakai.. Yor in the Bourbaki Seminar (Yor. Meyer in the appendix of Emery. 1990.. 1972. cf. Additional remarks on references (1) For more complete treatments of materials discussed above.A. 1991. e. Bass. Meyer. among others. for models connected with Boltzmann's equation of Maxwellian gas. 1972. (5) The formula for Wiener chaos expansion (ItS's multiple Wiener integral expansion) for solutions of Markovian SDE's has been obtained by Veretenni- kov-Krylov. 1984. 1975. Kunita. 1988 and Revuz-Yor. Watanabe. as have been developed in the most complete and elegant form by P. 1969. Kusuoka. Protter. a strong solution ofa Markovian SDE is a continuous functional of a driving Wiener process and its stochastic area integrals put together. 1975. Watanabe EP[exp(aS(l'2)(1)lw(1) = 0)] _ sin ~/2' I~l < 2re .g. 1996.. e. (7) For examples of SDE's involving Poisson point processes. e. . McKean. 1975) and Friedman. 1998) An important implication of his theory is that. Durrett. K. 1980. 1987. In this connection. we would refer the reader to Dellacherie-Meyer. Stroock-Varadhan.g. cf. the following books are recommended: Ikeda-Watanabe. 1988 for the process on the boundary of a diffusion process in a domain with Wentzell's boundary conditions. J. (4) For approximation schemes of solutions of SDE's and numerical methods.sinh a / 2 ' ~ E R . an expository article "A short presentation of stochastic calculus" by P. (6) For applications to nonlinear filtering theory. Kallianpur. e. 1979 (Russian original.g. Krylov. 1990 and also. we should mention of recent works by T. cf. Karatzas-Shreve. we would list two expository articles. (8) For additional references to the Malliavin calculus. 1965.A. 1969. 1982). Gihman- Skorohod. 1992. (2) We could not give a full account on the so-called "general theory of processes" and theory of semimartingales and stochastic integrations based on it. 1976. C. we would add an expository article by M. Lyons on the differential equations driven by rough signals (Lyons.

W. Probabilitds et potentiel. Prob. London Math.v a l u e d W i e n e r process because it is c o n t i n u o u s u n d e r the n a t u r a l t o p o l o g y on V(M) a n d o f s t a t i o n a r y i n d e p e n d e n t increments. Kirsh and B. J. R. M. C. I f we set A(t)(x) = ~ 1 A k ( x ) w k ( t ) -]. Chap. Friedman. Berlin. Prob. math. Volume 1.v a l u e d W i e n e r process a n d we can o b t a i n m o r e general stochastic flows o f d i f f e o m o r p h i s m s f r o m solutions. Trans. Control theory and topics in functional analysis III. Cambridge University Press. Davis. Bass. 1989. 1992. Calif. Berkeley. Vienna. Stochastic Differential Equations and Applications. 1982. (1951). Dellacherie. Stochastic Calculus in Manifolds. Meyer (1980). F. Math. France. Eells. Bismut. K. J. Emery. Political Economy 81. Belmont. M. then t ~ A(t) is a stochastic process t a k i n g values in the space V ( M ) f o r m e d o f all vector fields on M.637-654. 57. 958463. Varaiya (1974). References Airault. 179-185. 1989. K u n i t a . Cycon. Stochastic Differential Equations on Manifolds.-M. and P. Anal. 1978. Intern. Diffusion processes in genetics. W. (1982). Wadsworth. C.v a l u e d W i e n e r processes t h a n those given in the f o r m o f A(t). J. and A. 26. Durrett. and P. Springer.. Scholes (1973). T. m o r e general V ( M ) . 213.-M. M. 25-26. Black. Elworthy (1976). (1984). Bull. pp. Cf. M a l l i a v i n . 335-347. It m a y well be called a V ( M ) . and M. (2). Paris. Cambridge. 227346. J. Brownian Motion and Martingales in Analysis. A. however. I. Probabilistic Techniques in Analysis. Ast6risque 157-158. LNM 381. Formules de localisation et formules de Paul L6vy. Bismut. pp. In S~minaire de Prob. J. Soc. and P.A o ( x ) t . Press. (1989). (1974). Springer. Chap. A. H. pp. Froece. C. Picard's theorem and Brownian motion. 112. F. IntEgration g+om&rique sur l'espace de Wiener. Math. 3-52. Sc. (t982). J. Simon (1987). atomic energy agency. we need to c o n s i d e r m o r e general S D E ' s t h a n those t r e a t e d in this article: C o n s i d e r the S D E (76) on a m a n i f o l d M. Rennie (1996). Univ. 2. The pricing of options and corporate liabilities. VIII. 1969. D. Math. Y o s h i d a . 1990 on these topics. (10) To discuss the stochastic flows o f d i f f e o m o r p h i s m s in a full generality. Schrddinger Operators with Application to Quantum Mechanics and Global Geometry. H. . (1995). Cambridge University Press. Amer. (9) F o r stochastic calculus o n m a n i f o l d s a n d its a p p l i c a t i o n s . Ann. I k e d a . K. R. J. Cambridge. One-dimensional stochastic differential equation with no strong solution. T h e r e exist. Stochastic dynamical systems. Berlin. The Atiyah-Singer theorem: a probabilistic approach.W a t a n a b e . In Colloque Paul L~vy sur les Processus Stochastiques. Berlin. 1993 gave a p p l i c a t i o n s o f the M a l l i a v i n calculus to a s y m p t o t i c p r o b l e m s o f statistics in the m o d e l o f small diffusions. (1988). (1984). and D. E l w o r t h y . New York. NIV. 37 58. Soc. Elworthy. Springer. In 2rid Berkeley Syrup. Financial Calculus. Stat. Hermann. and P. Dellacherie. R. Springer. Meyer (1975). Dellacherie. M. H. The multiplicity of an increasing family of a-fields. Hermann. Malliavin (1988). the following b o o k s m a y p r o v i d e useful i n f o r m a t i o n s : M c K e a n . Itd's stochastic calculus and its applications 931 N. B. Barlow. 56-99. (1975). E m e r y . New York. Paris. Feller. A. Academic Press. Funct. Int6grales stochastiques par rapport aux processus de Wiener et de Poisson. V-VIII. 353-362. (1975).. G. The n o t i o n o f S D E ' s can be generalized to a n y V ( M ) . Soc. Davis. Baxter. Probabilitds et potentiel.

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